The transformation of NZX

Prior to NZX demutualizing it was a mere shadow of what it is today. Mark Weldon inherited:

1) An exchange that had meagre resources and a long track record of low or no profits.

2) An exchange that had failed to grow its market capitalisation back to the 1987 levels, (and still hasn't) unlike most other exchanges in the western world.

3) An exchange with internationally low liquidity levels, which of course in a material sense means low volumes to be clipped by the exchange and brokers.

4) An exchange that struggles to attract new listings of quality, which means in a material sense less shares to sell and less volume to be clipped and less listing fees.

5) An electronic exchange with a number of bugs and inefficiencies, particularly driven from mismatches between the exchange's transactional activity and the share registry asset recording function.

6) A struggling broking community, for the same reason that NZX struggled, lack of volume.

7) Members of the exchange sick to death of living in a small economy watching paint dry. They wanted some dynamism in the market, so they could return to the glory days of making money like they enjoyed in the mid 1980s and who also wanted to extract the value out of the exchange in cash.

8) A nation of people who had limited confidence in investing in shares generally and in NZ shares in particular.

9) And finally he inherited a regulatory framework based on contract, not statute, with that contract having many commercial pulls in opposite directions the net effect being a regulatory framework that was moribund and catatonic.

In short a high flying New Zealander returning home inherited one of the worst exchanges in the world when he could freely have chosen to run one of the better ones, or more likely run a merchant bank. If he had chosen the latter he might now of course be unemployed.

The migration to a corporate structure created a number of major issues and highlighted a few that already existed to government agencies.

What would happen if our exchange was taken over by foreigners and we became a satellite of another country? Simple answer is this: If we lose our ability to form capital locally we lose our ability to innovate and grow and we may as well just become a state of Australia. This was obvious to the pollies too; you see they are not always stupid. The answer to this dilemma was to adopt a constitution for NZX which restricts any shareholder to no more than 10% of the company. This fix however creates other issues.

The next problem was this: If NZX was a company and it listed on its own exchange, it would then be the buyer and seller on the listing contract and would have a conflict of interest in respect of its own activities, which could then freely bring the whole market into disrepute. Thus the Securities Commission was given an oversight role on NZX's activities, and further any changes to the listing rules (the contract) had to be approved by the commission.

To date the Securities Commission has adopted a limited interest in NZX. Perhaps they could some time explain the influence they have had if any over the re writes of the listing rules. They have certainly had no input into regulation conducted by NZX.

The listing rules allowed NZX to grant waivers, of the rules. Shit, this meant that NZX could enforce its rules on everyone else but waive them for themselves. Worse as NZX investigated breaches and prosecuted them, judged the results of the prosecution and fined the offenders, this too created a terrible conflict. How would NZX treat itself if it were to breach the rules?

Thus operational separation was insisted upon by the Government for the regulatory and waiver functions of NZX, thus it this is now a separate division of NZX. A similar debate occurred on the unbundling of Telecom, how far we should go, operational, structural or the whole hog legal separation. NZX, which is way more significant to our wellbeing got the lowest level of separation, operational.

Telecom had enforced on it structural separation and only just avoided legal separation. You do have to wonder what pollies think when something as fundamental as the integrity of our capital markets is dealt with with a fraction of the weight of interference compared to the stamping on Telecom.

What the government agencies didn't, however, deal with is the clear and direct conflict in the listing rules, being the tension between the profit motive and the integrity of the market. If you do nothing at all confidence disappears and you have no volume, or do you? Unlisted proves that proposition wrong. If you do too much you have no listings and no volume.

If you beat up a big company it might migrate to a friendlier listing environment and stuff the whole market. In NZ if any of these companies - Telecom, Contact Energy, Fletcher Building, SkyCity - left the exchange and listed in, say Australia where by the way they are already listed anyway, the NZ market would not be viable due to volume loss. This tension, which is as old as the formal exchange itself, was ignored. And that tension favours light handed regulation, especially of the big companies.

Upon Mark's appointment he was issued shares equal to 5% of the issued capital, and has subsequently increased his holding. A couple of years ago the board attempted to get passed a bonus plan that would have moved Mark to the maximum permitted under the constitution. Shortly after the corporate birth a number of listed companies bought shares in NZX.

I wonder if they did this to have influence over the regulatory process that might be applied to them? Probably not. The two initial significant shareholders were Carmel Fisher and GPG, and possibly Tony Gibbs. I think Only Fisher Funds is still a holder today. Thus the board is dominated by the two major shareholders Fisher and Weldon.

Due to the widespread of ownership of NZX and the lack of a number of counter balancing influences, any shareholder who holds 10% can effectively move the board around. The board in turn can move Mark off and Mark can in turn deal with the management team including the regulation division, which is in essence just a subset of the other functionaries within the business as regulation is not a fulltime function.

Carmel is an active shareholder and has been known to pull her weight with boards. Her and Mark appear close, and thus these two together run NZX. This was obvious to me when I attended an AGM of NZX and did my "let me kiss your ring my liege, hail King Mark of Weldonia" speech.  This was a bit rude of me as at the time he was not married and was not wearing a ring, but I doubt that Mark thinks of me as an arse kisser. At that meeting NZX was adopting a rule change which I had dubbed "auto pilot" More on this later.

So what Mark inherited was a barren little empire with very good structural bones. He inherited it as an autocratic emperor, and all we could hope for way that he was more like Elisabeth II rather than Henry VIII. The Securities Commission is, at best, a United Nations in the context of this analogy with its offices and support network situated in the territory of Weldonia, governed by King Mark. To impose its will if the NZX were resistant would require more resource and commitment than the Securities Commission has displayed to date.

Mark controls, passively or actively, the board. The board mandates him to act. He runs the exchange, makes all commercial decisions and also supervises the role of investigator, prosecutor, judge, jury and penal agent. Perhaps the Sheriff of Nottingham is a better description.

Next blog: And how has King Mark run Weldonia?