Dialogue: Takeover of the NZSE by the ASX?

By LLOYD MORRISON*

The following discussion paper was written and disseminated by Wellington merchant banker Lloyd Morrison last November.

I have set out my views on the proposed merger between the New Zealand and Australian Stock Exchanges (‘NZSE’ & ‘ASX’). While the following are my views, they also reflect the views of Morrison & Co and of Infratil, a significant listed company which has major ownership positions in a number of New Zealand's key infrastructure assets.

BACKGROUND

[i] Globalisation and the technology to facilitate it are driving towards the trading of securities on a 24 hour international basis. This trend is inevitable and generally to New Zealand's benefit.

[ii] Most listed companies in New Zealand have a below average track record of performance. Allied with poor Government performance over many years and a declining New Zealand currency, this has resulted in inadequate investment returns for both local and international investors who have invested in shares listed on the NZSE. This underperformance is overwhelmingly the major reason why international investors currently have limited interest in investing in shares listed on the New Zealand Stock Exchange.

[iii] The New Zealand Stock Exchange is a statutory body established under special legislation. Ownership of the NZSE is effectively by membership seats on the NZSE. Other bodies and legislation affecting governance include the Companies Act, the NZSE Market Surveillance Panel, the Takeover Panel (from 1 July 2001), the Securities Commission and the Commerce Commission.

[iv] The NZSE and the Australian Stock Exchange (ASX) have been discussing a merger of the two exchanges, which would, to all intents and purposes, be a takeover by the ASX, given their relative sizes.

MERGER

The NZSE and the ASX are promoting a merger of the two stock exchanges. The basic reasons given in support of the merger are listed below (with my comments in italics under each point):

* a merger is an inevitable part of the trend towards global trading of securities;

Wrong: further globalisation of trading of securities is inevitable. A merger with the ASX has nothing to do with such globalisation. It should also be recognised that, while bigger than the NZSE, the ASX is a tiny exchange in world market terms, with no or limited ability to impact on the terms or timing of further globalisation of securities trading.

* the merger would result in a lower cost of capital for larger companies listed on the ASX;

Wrong: a company's cost of capital is largely determined by the risks/potential returns of its assets/businesses; if a company's operations do not change, then the cost of capital will remain the same no matter where it is listed (assuming such factors as tax are not affected by the listing). Some commentators may suggest that the governance of a particular exchange may impact on a company's cost of capital to the extent that it impacts on investor risk. In my view there is nothing in the ASX rules or governance which is better/lower risk for investors than the NZSE. Nevertheless, importantly, if the cost of capital for New Zealand companies is believed to be adversely impacted by inadequacies of the NZSE's governance and reporting standards then the NZSE should rectify these itself!

* the merger would facilitate greater trading of New Zealand shares and will increase the interest in New Zealand companies by international investors;

I do not believe this to be the case. As noted above, the primary reason why international investors are shunning New Zealand is the historic poor performance of the NZSE + the even worse currency adjusted returns.

New Zealand, as a country, and New Zealand companies need to perform well economically - if they do so, there will be no shortage of supporting capital.

The NZSE should be working to do whatever is required to facilitate trading of New Zealand securities internationally e.g. adopting reporting standards consistent with those in the US; linking trading of New Zealand listed shares to those of other exchanges. A merger with the ASX will not make globalisation of trading easier or earlier.

* the ASX would 'protect the identity' of New Zealand companies by some sort of separate umbrella identification on the ASX;

I do not accept this will be the case. Under a merger, it is inevitable that, over time, governance would move to Sydney/Australia in terms of Securities coverage/enforcement/listing. It would become increasingly hard for the New Zealand participants to maintain any separate identity and, in fact, there could be a disincentive to do so.

A key requirement of investor support for New Zealand companies is information. To ensure stock coverage requires an active interested business community. Many medium and smaller sized New Zealand companies are less likely to be covered by brokers if their listing is on the ASX. This will also make it harder for such companies to raise growth capital.

* a number of New Zealand's major companies have threatened to move their formal listing to the ASX if the NZSE does not merge with the ASX.

There is little one can do about this. If companies want to leave the NZSE's primary listing, then it will probably be for other reasons - e.g. Lion & Fernz moving head offices to Australia, with more assets there than in New Zealand. In another example, if Carter Holt was to leave, I believe this would do little to increase their attractiveness to international investors. The critical factors affecting CHH are the outlook for its existing businesses or a dramatic change in the mix of assets which it owns.

The threat of bigger companies leaving the exchange in the short term seems to be a bigger threat to the small group of 'owners'. Importantly, if a big company leaves the NZSE, the value of the NZSE would decline to the extent less trading is taking place on the NZSE. However, given the exchange has a wider ownership in the sense that it is a critical part of New Zealand's capital markets the merger should not be impacted by consideration about the short term value a small number of sharebrokers might or might not get for their seats. The primary issue is the role of the NZSE in terms of benefit to New Zealand's future economic position.

RISKS OF A MERGER

More than doubting the purported reasoning for the merger, I believe there are strong reasons/risks which mean such a merger is not in New Zealand's interests :

* The NZSE will lose sovereignty over the governance of New Zealand listed companies and a core component of our capital markets;

In my view, the NZSE is a well governed and efficient stock exchange. Governance operates through the listing rules, with bodies such as the NZSE Surveillance Panel and the Securities Commission ensuring appropriate regulation and codes of conduct. I believe that access to such bodies is not only very easy but that their jurisdiction is both impartial and equitable. I have had a lot of experience of equivalent bodies in Australia and do not consider the equivalent system to be as good as our own for New Zealand based companies. Unquestionably, it will cost significantly more and take more time for New Zealand companies to deal with regulatory organisations based in Australia.

* Higher exchange costs and lower efficiency for New Zealand based companies;

Technology has meant that a small exchange can largely enjoy the economies of scale/low trading costs of a bigger exchange. In fact, I understand the low cost of New Zealand's software and systems and the efficient head office structure has made the NZSE one of the most cost efficient exchanges in the world.

* Higher compliance costs;

In addition to the higher listing costs for companies, governance costs, including legal and financial advisory costs when dealing with regulatory bodies are more likely to be set by Australian cost structures and will favour the regulatory experience of Sydney/Melbourne professionals. These costs are materially higher than equivalent costs in New Zealand. Costs will be higher during listing processes, on a day to day administrative basis and on governance issues.

* Loss of corporate offices and financial services;

I believe that a natural consequence of a merged exchange will be that Sydney will become increasingly attractive as a base for head offices of New Zealand companies. New Zealand cannot afford to lose existing head offices or local entrepreneurs.

Capital raisers, capital aggregators and providers, support professionals including stock brokers, corporate finance advisers, corporate lawyers and accountants, will focus on Sydney/Melbourne with a major loss of creative talent from New Zealand. Maligned as this sector is, it has historically employed many of New Zealand's most creative and intelligent people - many of whom are today responsible for the emerge of a growing, albeit still fledgling, creative technology sector.

* Australia is not our natural partner.

International trading is about globalisation. If any country is critical in this process, it is the US. The NZSE should be aligning itself with US market practices. Australia might be closer to New Zealand, but there is insufficient substance in Australia's financial system or capital markets to improve New Zealand's position.

Ironically, Australia has proved a weak market for New Zealand companies in terms of capital support. While all flows are currently weak, during periods of strength NZSE listed companies have primarily garnered support from the US and Europe first and then from Asia. Australian capital market players have never been much more than patronising in their commitment to the success of New Zealand companies.

In my experience, the NZSE and associated governance bodies provide an equitable and efficient system for disputes and corporate accountability. While clearly many will have their own views and experiences, there is nothing in the Australian system which recommends it over New Zealand. On the contrary, I have never found the Australians particularly respectful of New Zealanders or of New Zealand companies and feel the risk of less equitable outcomes under an ASX scenario is higher.

There is no doubt that New Zealand's economic performance has been woeful for 30-40 years. New Zealand's corporate performance has been similar over this period. The NZSE and international investors’ perception of it reflects that track record. However, unless we are closing the door to the potential for a future recovery, we cannot afford to lose our local exchange. If we are to rebuild our economic health, we will need the support of local capital markets which reflect New Zealand's new corporate image, its efficiency and competitiveness, its flexibility and openness to technology and globalisation.

The sovereignty of the NZSE is more important than many people are recognising. It is an issue that will impact longer term on far more people than the sharebrokers who are predominantly giving consideration to the issue at present. In fact, I consider that members of the exchange have a material conflict of interest on this matter that should be taken into consideration. As the "owners" of the exchange, it must be difficult to ignore a financial offer for their seats which reflects short term trading of shares in companies which have threatened to move their primary listing to Australia. However, it needs to be noted that New Zealanders should be considering whether the exchange, like our legal system, is an integral part of our economic system and is an institution which reflects our capital markets. The NZSE exists through special legislation. It does not exist for its current "owners" any more than the legal system does for lawyers.

WHAT SHOULD HAPPEN?

I believe the following steps should take place instead of a merger :

[i] The Government should endorse the NZSE as a integral component of New Zealand's capital markets and system for the governance of companies based in New Zealand;

[ii] At the same time, the Government should express its support to the NZSE for the trading of the shares of New Zealand listed companies on an international basis and should seek guidance from or even require the NZSE to report back to it about measures the NZSE is taking to facilitate such trading (if any) e.g. the Government should be pressing to get the NZSE to adopt reporting standards which meet those of the US Securities & Exchange Commission, which is the governing organisation for the US markets.

* I believe the NZSE should adopt US sucurities rules but use our governance bodies (Takeover Panel, Securities Commission etc) to enforce them. This way, we will facilitate global trading without foregoing the advantages of cost, efficiency and equity which I believe gives us a potential advantage today*.

* I believe the NZSE should have a comprehensive programme for adopting US standards so that international institutions have few, if any, impediments to trading shares on the NZSE. For example, part of the adoption process would involve all participants in the securities business in NZ qualifying for accreditation under US rules. A further measure could involve realtime quotes for all major listed companies in $US.

[iii] The Government should support demutualisation of the NZSE, but only with some strong caveats :

* there needs to be far wider representation in terms of governance of the Exchange from non-brokers. Parties/participants who need representation include small investors; institutions; corporates (incl technology representation);

* the NZSE must remain an independently run New Zealand governed organisation. Unfortunately, this will mean a need to limit ownership influence in terms of any single or related parties and, potentially, a limit on foreign ownership. While this will affect the value of the NZSE financially, I believe the primary measure of the NZSE’s success ought not to be financial – rather it should be judged on its efficacy as a critical platform in facilitating the success of New Zealand’s capital markets.

* H.R. Lloyd Morrison is Executive Director of

Morrison & Co

and is a director of Utilico International Ltd, HRL Morrison & Co (Australia) Pty Ltd, Morrison & Co Infrastructure Management (the manager of Infratil NZ), Morrison Holdings Ltd, Port of Tauranga Ltd, Wellington International Airport Ltd and Pencarrow Funds Management Ltd.