The New Zealand Exchange (NZX) debuted on its own exchange in June after demutualising and raising $10 million from a public float. Later this year it plans to launch a new Futures and Options Exchange (NZFOX).
SC: We've had a futures market and it didn't work. Why does NZX think it can make one work? What will NZX do differently? Isn't New Zealand just too small to have an effective futures and options exchange?
Chief executive Mark Weldon (MW): There are very substantial points of difference to what has occurred here in the past in terms of what the business model and the structure of the market looks like. The market participant rules have been substantially redrawn. Up until these new rules are read into law, they anticipated the broker to look very much your all-singing, all-dancing 70s style dealer. With specialist niche players emerging, there's no point these people being charged with doing things they don't do. For example, someone can just clear and be a technology provider. The change will allow connectivity to players who may not have been traditionally connected to the market. Second, the rules also anticipate market makers. No one has previously encouraged market makers to make two way prices. What you've had effectively is similar to the equities market, there's a bid and ask and you're hoping for a natural match. Our belief is that you generate a lot more liquidity from a market maker model. Order execution will be able to be entered through Reuters or Bloomberg or IRIS terminals. IRIS spans the Tasman and is also the biggest provider of data and front-end access on the Australian side of the market. If you look at the SFE and go into the offices of Citigroup, they use Sycom, a SFE proprietary terminal. The universe is substantially extended (with NZFOX). If you compare it to the NZFOE, only two or three brokers in New Zealand ever took Sycom. Going with an open interface, all the brokers are going to take it on because they (futures and options) provide very substantial advantages in the underlying physical market. What we've done over the last three months is run education accreditation courses. Somewhere in the region of 200 New Zealand brokers have been through these courses and have sat the exam. They have product knowledge at a pretty detailed level. We've never really had a sales force out there that's understood these products in a detailed way. We're starting with a very limited set of products. At one point, the SFE had about 40 different products which is just not successful. We will never have more than a handful of products. We don't think it would be sensible to have 50 different options on the market. We will limit it appropriately to some liquid stocks, and a headline index futures contract, where there's liquidity in the underlying stocks - Telecom's a very liquid stock.
SC: Why is the exchange putting up its data charges so much? Is NZX taking advantage of its monopoly position?
MW: That's not factually correct. No data charge has gone up. The current executive team inherited an extraordinarily complex, ad hoc structure. There was no one set of formal contractual terms, no one set of two-way guarantees or prices. Major data vendors have not had any change at all. For reasons that are obscure at best, there were particular players in the market with whom the exchange didn't have a contract. We don't want to favour any vendor over another vendor. The other way of looking at it is that they have had an unlevel playing field to their advantage for about a decade.
SC: How much of the recently announced profit increase was due to increased data charges? Why did trading revenue increase so much?
MW: Zero. The first tranche of invoices for that stuff is now going out. One of the things about an exchange as a business is that it's an extraordinarily scaleable business. When you're running a market on both the trading and listing sides, once you're beyond a certain scale, it flows straight from the top line to the bottom line. The critical thing is keeping your cost base down. What you saw last year was a very substantial increase in both the number of trades and the value traded. Both of those things are pretty critical revenue drivers.
SC: NZX has no debt - isn't that inefficient? Are there expansion plans or other plans to address this?
MW: Our cost of equity when we raised it was 3.3% so it was pretty cheap. Clearly, in most businesses, especially businesses that make widgets, you want to optimise your balance sheet. It's a very difficult question for a company such as ours as to what is an optimal level of debt. It has an obligation to shareholders and an obligation to the integrity of national capital markets. In our view, and if you look around the world at exchanges in Hong Kong, Singapore, Sydney, London, Germany, they keep a lot of cash on the balance sheet. There's very little analyst comment about that. One of the things that would most frighten off international investors is a situation where the market operator looked like they might be at risk. If you took a normal curve of events, even though a one in a 100 years situation isn't likely to occur, lets run the scenario and see how much cash we have to keep in order to make sure we can negotiate that successfully. Our balance sheet right now has money we've raised and we're looking at ways of spending it. It doesn't make sense to gear at this stage.
SC: What is your view of how the NZX 50 index is working? Do you think it's widely used?
MW: Probably the best way to answer the question is to look at the different segments of the population to whom an index is relevant. Our understanding is all but one or two of the funds in this country are now benchmarking against the 50. With the one or two others, it's a matter of timing. The second group is retail investors. (The Top 50 index) has become part of the popular venacular very quickly. The analysts/academic community tends to use both (the top 50 and the top 40 index), depending on the time frame.
SC: Can you see any merit in requiring companies to disclose transcripts of their private briefings to brokers and/or large shareholders to all shareholders?
MW: Under a continuous disclosure regime, no company can make one part of the market better informed than any other part of the market. There are some companies now who will not speak on a private basis to brokers or to institutional investors. Under a periodic disclosure environment where you are only required to release information at certain points of time, and where there are no boundaries on what you could communicate outside of those periodic disclosures, I would agree with that comment. With a continuous disclosure environment, I think the basis of that question is substantially lessened. If everyone had to disclose transcripts of every conversation they had, there would be no conversations.
SC: A sharechat reader with $50,000 to invest asks what is there to encourage new investors to the NZX, expecially when institutions always seem to get company news first and "the scraps are left to the mum and dad investors."
MW: Continuous disclosure means the ordinary investor receives information at the same time. The issue here is that the ordinary investor has a day job whereas a broker's looking at the market all the time. But it's not like they will have any information which isn't available to anyone else who wants to look. The average portfolio of people with about $50,000 in New Zealand is pretty inefficient. They tend to be in property and cash. On the New Zealand exchange - it's both a strength and a weakness - the companies are amongst the largest dividend paying companies in the world. If you look at New Zealand companies, let's take Sky City for example, if you go to Vegas there are a million casinos and it's extraordinarily competitive and there's no real guaranteed future. One of the benefits of being a small country is that at a certain point size becomes a pretty effective barrier to entry. No one's going to build another Sky tower. There are a lot of companies in New Zealand that pay very, very high dividends, much higher than you will receive from interest in a bank and you get exposure to upside. Last year the index was up 26% and the best guess of a property index was up 22%. $50,000 isn't enough to contemplate the exchange rate risk of putting it offshore. Regardless of what your view of US equities might be, you've got to have a view on the exchange rate. I don't know anyone who's good at picking the exchange rate.
SC: Do you still swim?
MW: I do still swim. I'm finding it more difficult to swim here, strangely enough, than I did in the States. The reason is that people here are a lot healthier and there are more people at the pools. It's the best thing I know to keep my head clear and to keep me reasonably sane.