The Growing New Zealand's Capital Markets 2029 report is a depressing document.
Yes, the report released on Monday received numerous complimentary comments, but its underlying message is that brokers have raised the white flag over the NZX.
There are numerous indications of this, including the comment that "each of the five primary retail NZX firms has moved from broking models to wealth management models with a concentration on asset allocation and portfolio construction".
Another is: "There are about half a dozen broking or banking firms remaining. For these firms, a small IPO can take as much resource as a large IPO but earn less. They can also be less certain with regard to completion, and arguably riskier to sponsor. In short, the opportunity cost of an investment bank undertaking a small IPO can be quite large".
The clear message from the report is that brokers, who should be the main promoters and principal gateway to the NZX, have switched from stock broking to wealth management and are reluctant to sponsor small IPOs.
This shouldn't be a surprise to NZX observers as this trend has accelerated in recent decades.
Three decades ago, the NZX was supported by nearly 100 broking firms spread throughout the country. At the end of 1986 there were 91 broking firms with nearly 200 individual members who effectively owned the exchange under a mutual structure.
This was the wild west era with almost no rules and regulations, particularly as far as insider trading and market manipulation were concerned.
Senior broking partners, who made a proverbial fortune because of the 2.0 per cent minimum brokerage rate, railed against the Securities Commission when it attempted to introduce rules to curb the excesses of the 1980-87 period.
Brian Gaynor: Inside Shareholders' Association annual investor conference
Brokers continued to aggressively lobby against any proposed regulatory changes following the 1987 crash.
They successfully opposed the reforms recommended by the Report of the Ministerial Committee of Inquiry into the Sharemarket, chaired by former Reserve Bank governor Sir Spencer Russell.
They also successfully delayed the introduction of the Takeovers Code, which aimed to treat all shareholders equally, from 1993 until 2001. In other words, the main aim of the domestic stock exchange in the 1990s was to maintain the unregulated environment of the 1980s when retail investors were misled and manipulated.
However, this strategy backfired as retail investors deserted the sharemarket for the residential property market. This was an astute decision, as the total value of the country's residential property increased from $221 billion to $282b between 1998 and 2002 while the total value of the sharemarket declined from $47.2b to $41.5b over the same period (see table).
Meanwhile, the investment banking divisions of the major broking firms continued to search for foreign buyers to make takeover offers for our listed companies.
In 1992, one large broking firm strongly supported the takeover of the Bank of New Zealand by National Australia Bank and thwarted an aggressive campaign by individual investors to keep the bank in New Zealand hands.
This takeover had a devastating impact on the domestic sharemarket, particularly as ASB was sold to the Commonwealth Bank of Australia for a proverbial song a few years later.
The BNZ and ASB sales showed that New Zealand broking firms were far more successful at generating huge fees by representing foreign buyers of our companies than promoting new NZX listings.
In the late 1990s and early 2000s, numerous large companies disappeared from the NZX, including: BNZ Finance; Trust Bank; Wilson & Horton; Milburn; Progressive Enterprises; Lion Nathan; Nufarm; St Lukes; TransAlta; and Baycorp. Several of these exits were strongly supported by NZ broking firms.
But the most important change occurred on December 31, 2002, when the exchange was demutualised and turned into a limited liability company registered under the Companies Act 1993.
As part of this demutualisation, the 331 broking firms and their members received 10,000 shares each for nil consideration, a total of 3,310,000 shares. Five months later NZX had a one-for-one share split, with the original 3.31 million shares converting into 6.62 million shares.
In mid-2003 the NZX launched an IPO whereby the owners of the original 6.62 million shares were offered 3.29 million new shares at $1.50 each while institutions and the NZ public were issued 2.78 million shares at the substantially higher price of $3.60 each.
The newly listed NZX had 12.685 million shares with the 331 pre-demutualised firms and stock exchange members owning 78.1 per cent of the newly listed company.
However, these majority shareholders had lost confidence in the exchange, particularly in newly appointed chief executive Mark Weldon, and they began dumping their shares in large volumes. This was the first clear public sign that brokers had lost confidence in the domestic bourse.
Fast-forward 16 years and the NZX is a totally different entity, with only 16 brokers trading securities compared with 36 in 2002 and 91 in 1986. Only five of the current 16 brokers are serious market participants.
In addition, these brokers now own few NZX shares compared with 100 per cent ownership prior to the 2002 demutualisation and there are only 127 listed NZ companies compared with 145 in 2002 and 339 in 1986.
The one bright spot is the huge increase in total sharemarket capitalisation from $41.5b in 2002 to $153b at the end of August, with the four former Crown-owned electricity generators and Auckland International Airport representing one-third of this increase.
But the biggest change has been the massive switch by the major market participants from the broking model to the wealth management model. This has been an astute move as the three major firms — Jarden, Craigs Investment Partners and Forsyth Barr — have estimated private wealth assets of around $39b compared with total sharemarket trading value of $33.5b in the 12 months to June 2019.
Assuming average private wealth fees of 0.7 per cent, the three large firms would have generated revenue of around $26m from their private wealth operations, compared with total industry broking fees of around $17m, assuming an average brokerage rate of 0.5 per cent, for the June 2019 year.
Brokerage rates are under pressure because of the huge increase in passive fund managers, who are driving down transaction costs.
The websites of the major firms clearly indicate that they have moved dramatically from stock broking to private wealth as they profile far more private wealth advisers than traditional stockbrokers.
The major flaw of the 2029 report is that it hasn't addressed this evolution from the broking to private wealth model and the impact this is having on the NZX. It is obvious that the residential property market would be severely affected if real estate agents focused on managing property instead of helping people to buy and sell homes.
Real estate agents are often criticised, but they play a vital role in facilitating a market for the sale and purchase of residential property. Who is going to replace the traditional stockbrokers who have moved to private wealth?
The big broking firms have raised the white flag over the NZX because of the massive change in their business model, particularly as the large percentage of NZX off-market trading makes it extremely difficult for new firms to fill the gap created by the massive shift away from traditional stock broking.
Another feature of the 2029 report is its strong focus on KiwiSaver, which will be increasingly identified as the solution to most of New Zealand's problems, including the building of schools, hospitals, roads and the reduction in public debt.
Politicians must strongly resist the temptation to allow KiwiSaver funds to be used for non-core investments, particularly the 2029 committee's suggestion that illiquid KiwiSaver funds should be established where investors may not be able to get access to their funds when they reach 65.
This illiquid KiwiSaver option should not be adopted nor should many of the other relatively lightweight suggestions in the 2029 report.
- Brian Gaynor is a director of Milford Asset Management.