Tinkering won’t fix overregulation of capital markets

The suite of reforms pitched by the National-led coalition government will go some way to addressing isolated issues in New Zealand’s capital markets, but won’t fix the overarching mistakes made more than a decade ago.

That’s the view of David Wallace, managing director of investment bank Armillary Private Capital, which also operates the USX junior exchange.

Wallace sees the sweeping reforms in the wake of the domestic finance company collapse and the broader global financial crisis as importing legislation that, with the benefit of hindsight, doesn’t work.

“The entrepreneurship has been beaten out of the industry by regulation and probably the unintended consequence of regulation is that everyone has become wealth managers,” Wallace said.

That’s led to the expansion of discretionary investment management schemes, where an investor grants an investment house authority to buy and sell products on their behalf.

“We’ve got a lot of people in model portfolios and exchange traded funds – they want to keep it as simple as possible,” Wallace said. “We’ve got investors who don’t understand risk, we’ve got broking firms who don’t want to take risk, and we’ve got directors who don’t understand risk either.”

The 2013 Financial Markets Conduct Act was the cornerstone of sweeping securities law reform ushered in by John Key’s National-led administration in a largely bipartisan overhaul of the then-30-year-old legislation.

Leaving on a jet plane

That regime was deemed to have become unwieldy and its watchdog – the Securities Commission – thought to have been lacking teeth as thousands of retail investors were burned by the collapse of dozens of finance companies.

The Ministry of Business, Innovation and Employment has been evaluating the long-term impact of the law change, with its five-year update in 2020 showing a promising start, albeit hard to distinguish from the 10-year bull run markets had been enjoying.

The final phase of its evaluation was held up by the covid pandemic and has since been dropped, falling outside the government’s priorities.

“Work completed to date has yielded valuable information and suggests that overall the act is working well,” an MBIE spokesperson said in an email. “MBIE found that the act has contributed to improved confidence in the financial markets and more efficient access to capital, and that more innovative and flexible ways of participating in financial markets have emerged.”

Officials have now been tasked with working on a suite of projects to improve capital markets, ranging from adjusting disclosure requirements to reassessing director liability to reviewing takeover rules.

The first tweak was ushered in last week, giving companies considering raising money from the public greater leeway in providing financial forecasts – something seen as the most expensive roadblock for new companies to join the public markets.

Armillary’s Wallace said that kind of tinkering around the edges will make it easier for a firm to raise money using a regulated document, but long-term changes are needed for the underlying legislation to level the regulatory playing field where private companies have an easier ride.

“There needs to be realisation that this legislation put a certain handbrake on capital markets and that hasn’t helped with the process of creating capital to support growth companies,” Wallace said.

Dream about days to come

He agrees with Octagon Asset Management business development manager Matt Hardwick, who this week wrote in the National Business Review that the rise of passive funds has contributed to the dearth of new listings and initial public offerings around the world.

The declining demand for more expensive active funds management has meant public markets has lost a level of research and price discovery that benefits broader markets.

Oliver Mander, chief executive of the New Zealand Shareholders’ Association, said he doesn’t want to see a watering down of investor protections, but is in favour of a holistic review to clamp down on the regulatory arbitrage enjoyed by private companies.

“If we get that balance right it will be great for New Zealand investors,” Mander said.

The NZ Shareholders’ Association is a fan of introducing a threshold for meeting certain regulatory hurdles based on the number of shareholders on a firm’s register, which would match the risk to the potential wider public impact.

While the NZX’s lacklustre run of new listings has been well-known locally, other stock exchanges have faced similar struggles, with just four IPOs on Singapore’s SGX last year and the 45 on Australia’s ASX well short of the 120 average over the past five years.

Tell me that you’ll wait for me

Even New York is facing increased competition with the Texas Stock Exchange poised to launch next year, and a growing number of US companies shifting their headquarters to the Lonestar state’s more relaxed regime rather than stay in the well-established state of Delaware.

Wearing his Armillary investment bank hat, Wallace said hollowing out of public markets ultimately undermines private companies when it comes time to sell.

There’s a growing cohort of medium-sized companies in the $50 million-to-$100 million space that don’t have the capacity to scale and grow that private equity buyers want, and will struggle to attract potential buyers, he said.

And with KiwiSaver schemes being encouraged to invest actively in private assets, the dwindling scope of public markets makes it harder to value those unlisted entities.

“Without thriving public markets, how do you value them?”

Reporting by Paul McBeth. Image from Curious News.