Gaynor: The little exchange that couldn't

By BRIAN GAYNOR

The release of the New Zealand Stock Exchange (NZSE) annual report highlights how hopelessly unprepared the organisation is for demutualisation and sharemarket listing.

Its profit performance is woeful and it will need to be substantially reorganised if it is to attract widespread investor interest.

On the basis of its financial performance the NZSE will have a sharemarket capitalisation of less than $50 million, whereas the Australian Stock Exchange (ASX) and Stock Exchange of Singapore (SGX) have market values in excess of $1.3 billion.

The ASX was demutualised on October 13, 1998, and the next day it became the first stock exchange to list on its own market. It is a proactive and growth-oriented organisation that has outperformed the NZSE in every important area.

The total market value and annual turnover of the ASX is more than 20 times greater than the NZSE, yet Australia's population is just five times larger than New Zealand's. The number of listed companies and new listings is more than 10 times what it is here.

But it is in terms of corporate revenue and net profit that the ASX leaves the NZSE for dead.

In the 12 months ended December 31, the ASX produced net earnings of $A57.7 million ($72 million) on revenue of $A200 million. Its main sources of income are from clearing and settlement, listing fees and the sale of market data.

ASX's strong profit growth has been reflected in its sharemarket performance. The company has more than 16,000 shareholders and its share price has risen nearly threefold since listing in October 1998.

The Stock Exchange of Singapore, now called Singapore Exchange Ltd (SGX), is more relevant to us because the population of the Southeast Asian country is 4 million compared with our 3.8 million.

The SGX was demutualised on December 1, 1999, and was listed on its own exchange on November 23 last year. The company's objective is "to develop a vibrant, integrated marketplace for securities and derivatives that will be attractive to market participants in Singapore and elsewhere."

The SGX has been extremely successful in achieving these goals.

Per capita, its total market capitalisation, turnover, number of companies listed and new listings are well ahead of both the ASX and NZSE.

Its revenue and profit performance has been particularly impressive. The main sources of its income are from clearing and settlement, account maintenance and processing fees, and computer equipment rentals.

The SGX has been successful in bringing new products to the market. Its only weakness has been the 25 per cent decline in its share price since listing in November last year.

The ASX and SGX both place a great deal of importance on their electronic co-trading agreement. Under this arrangement, Australian investors will be able to buy shares in companies listed on the SGX, just as they buy Australian shares, and settle in Australian dollars.

Likewise, Singapore investors will be able to trade in Australian shares through the SGX and settle in Singapore dollars.

The NZSE has not developed any international alliances of this sort because it would be contrary to its business model. Basically, the exchange acts purely as a low-cost provider of market facilities. It returns most of its surplus cash to stockbrokers and makes little capital investment.

This business model, which is totally out of line with international practice, believes that individual brokers should promote the market and investors are primarily attracted to the sharemarket because of low transaction costs.

The different attitudes of the three exchanges are clearly evident in their websites. The ASX and SGX have attractive and comprehensive sites that contain current and historical share prices, graphs, company announcements, market statistics and much, much more.

By comparison, the NZSE has a substandard site with no main board company announcements, share-price graphs or detailed market data.

The NZSE's business model has been seriously flawed for some time but nothing has been done about it. The performance of both the market and the exchange as a corporate entity has suffered as a result.

For the year ended June 30, the NZSE reported a net profit of just $747,000 on revenue of $9.3 million. Brokers are probably not complaining because the fees paid by them to the exchange declined between 1991 and 2001, yet the NZSE's revenue increased from $6.2 million to $9.3 million over the same period.

The biggest increase in revenue over the 10 years was from sale of market data and publications. In other words, the NZSE charges for these services while the ASX and SGX provide most of this information for free on their internet sites.

Is this the best way for the NZSE to encourage widespread sharemarket participation?

One of the NZSE's biggest problems is its board of directors, which has all the appearances of an old boys' club. Most of the directors seem to have long-term contracts, regardless of their performance. Six of its 10 present members were first appointed more than a decade ago: Eion Edgar (appointed 1987), Malcolm Brown (1988), Hamish Taylor (1988), managing director Bill Foster (1989), Geoff Ricketts (1989) and Don Trow (1989).

Why are most sections of our society now subject to strict performance guidelines yet many directors seem to have guaranteed positions until they reach the mandatory retirement age?

The New Zealand Stock Exchange Restructuring Bill, which will sanction the demutualisation of the exchange, should be enacted within the next few months. The new entity hopes to list on its own market before the end of 2002.

The demutualisation and listing of the NZSE should be a catalyst for big changes, both in the organisation's business model and its board of directors. The new company will have to become more like the ASX and SGX - it will have to be marketing and product development-oriented. It will also have to build meaningful alliances with other international stock exchanges.

In recent years, the exchange has introduced the TeNZ passive funds and the New Capital Market in a blaze of publicity. But it has quickly lost interest and these products are fading into obscurity.

The exchange requires a complete change of culture; it needs to move from a cost-cutting operational-type environment to an aggressive growth and profit-oriented organisation.

This obviously means significant changes at senior management levels.

One of the more controversial issues surrounding demutualisation is the proposed shareholder cap. The ASX and SGX have 5 per cent legislated caps and are both moving to 15 per cent legislated caps.

These shareholder caps protect the exchanges against foreign takeover. But shareholder caps also protect inefficient managers and directors as they are then immune from a partial or full takeover.

From an efficiency perspective the shareholder cap is relatively unimportant as far as the ASX and SGX are concerned because they are well-run, profitable organisations.

But the NZSE is a different matter. It would be a disaster if the proposed 10 per cent shareholder cap acted as protection for ineffective directors and management.

On balance, a shareholder cap is the preferred option but to counteract this New Zealand Stock Exchange shareholders will have to be extremely active on governance issues.

The exchange's performance over recent years has shown that it will not meet the high standards set by its Australian and Singapore counterparts unless it is harangued and pressured by outside sources.

* bgaynor@xtra.co.nz