Minister of Commerce. Subject: Notice of Intention to Declare the Unlisted Securities Market Subject to the Securities market Act

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1 SUBMISSION To: Minister of Commerce Subject: Notice of Intention to Declare the Unlisted Securities Market Subject to the Securities market Act Date: 18 March 2005 The Minister has issued a notice of intention to declare the Unlisted trading facility subject to section 36B of the Securities Market Act. The Minister s stated reasons for this intention are that not doing so is likely to be detrimental to: the integrity and effectiveness of securities markets in New Zealand. the confidence of investors in securities markets in New Zealand. We note that these reasons are not peculiar to the Unlisted facility but rather are the only reasons that the Act allows the Minister to apply and they should be seen in that light. INFINZ does not believe that the Minister has sufficient grounds for reaching these conclusions at this time. Consequently, INFINZ does not support the Minister s intention. INFINZ takes the view that where (increased) regulation is being promoted, there is a strong onus of proof on the proposer of that regulation to show: that public harm is being done without the proposed regulations; and that the harm will be removed by the imposition of the proposed regulations; and that there is not likely to be other adverse consequences from the proposed regulations. It is our view that the Minister has not met any of these requirements in considering the application of the regulation to the Unlisted facility. In the paragraphs below we review the nature of Unlisted, the basis by which it should be assessed and a review of the risks and benefits of the trading facility. Institute of Finance Professionals New Zealand Inc. UNLISTED 1

2 Prior to Unlisted, public companies with dispersed shareholdings had two broad choices of organising trading in their shares: they could list on the NZSX (and now also on NZAX); or they could facilitate share trading by matching buyers and sellers through the company. In addition, buyers and sellers could trade directly through a number of means (private arrangements, public advertisements etc). In this submission, we refer to this type of trading as traditional Over the Counter (OTC). Unlisted is an extension of and a clear improvement on traditional OTC trading. By providing a facility that does little more than allow multiple buyers and sellers to deal publicly, there is much more robust price discovery and greater liquidity in the OTC sector of the market. These are clear benefits to both buyers and sellers compared to traditional OTC trading. We note that the Unlisted facility allows users to see the market depth for individual securities (the bids and offers in particular volumes at particular prices) which imparts considerably more information than traditional OTC. In addition, the factors that make up Unlisted s improvement on the traditional OTC market allows companies to raise capital at lower cost than would otherwise be the case; a clear benefit to issuers compared to traditional OTC trading. Other than liquidity and more accurate price discovery (both of which are sizeable benefits) INFINZ acknowledges that there is little further investor protection available when trading through Unlisted compared to traditional OTC trading. However, as there is no intention to limit traditional OTC trading, the following points must be true: The inherent risks to investors of trading through Unlisted (eg exposure to risks around insider trading and information disclosure other than covered by general Securities and Companies law) are acceptable in an absolute sense for at least some proportion of the market as they are allowed to exist in traditional OTC trading. If there is a case for further investor protection at this end of the market, the appropriate response would be through changes to Securities legislation not by potentially removing a facility that simply improves OTC trading Institute of Finance Professionals New Zealand Inc. UNLISTED 2

3 In this sense, the assessment of Unlisted should not be based on whether investors are exposed to these risks Unlisted is at its simplest, a step improvement on traditional OTC trading. The only material risk that is relevant to the assessment of whether harm is being done by the existence of the Unlisted facility is whether investors may be confused between the protections offered when trading through Unlisted compared to trading through a NZSX/NZAX facility. Addressing this issue does not entail closing down the Unlisted facility (see later comment). A secondary consideration may be the relative size of unregulated trading compared to trading through more regulated facilities. Although, in the unlikely event that Unlisted prospers dramatically at the expense of more regulated alternatives, it may be a case for reviewing their regulations rather than the existence of Unlisted. INFINZ is not aware of, and the Minister has not provided, any evidence that there is confusion amongst investors in regard to the protections offered through Unlisted compared to the NZSX/NZAX facilities. We are sure that investors using traditional OTC trading do not believe they are protected by the regulations pertaining (exclusively) to the NZX. We do not believe the addition of facilitating internet-based trading in shares on Unlisted should suddenly confuse anyone. With a size and trading value at around 1% that of the NZSX/NZAX, Unlisted cannot be regarded as anything more than the fringe trading facility it was established to be. We note that the average market capitalisation of companies on Unlisted is under $40 million. The average is skewed up by one company (Skyline with a market capitalisation of $240 million) and is trending down. INFINZ questions the apparent underlying assumption behind the notice of intention that Unlisted operates in an unregulated environment. All the companies using Unlisted are still covered by requirements of the Financial Reporting Act, the Companies Act and the Securities Act. Not availing oneself of the facilities provided by NZX can not be construed to mean companies fall outside of regulatory supervision. Rather, they are not subject to one small part of a much larger regulatory environment where that small part forms the Institute of Finance Professionals New Zealand Inc. UNLISTED 3

4 basis to the business model of the only registered exchange in New Zealand who must have a vested interest in seeing the removal of any contrary business model. INFINZ would also suggest that the Securities Market Act foresaw that market operations other than registered exchanges serve a purpose otherwise the legislation would not have allowed for them. Indeed, the Draft Guidelines on the Exercise of Securities Markets Act 1988 Declaration Power dated 20 November 2003 states officials consider the underlying policy rationale of the Act is the desire to facilitate the development of smaller and/or more innovative markets in new Zealand. Unlisted clearly falls within this rationale and should be seen as a facilitator of a market benefiting investors rather than a potential source of a lack of integrity, effectiveness and confidence. INFINZ believes that Unlisted (in its current form) is a useful addition to the share trading alternatives otherwise available. Our reasons for this are as follows: OTC trading is internationally understood and accepted. Unlisted operates like an internet based OTC facility. It is governed by the same regulatory framework as OTC trading. We believe Unlisted is a vast improvement over traditional OTC trading. It has the effect of making this end of the market more efficient. Contrary to the Minster s assertion that Unlisted serves as a disincentive for companies of the size and scale currently on Unlisted to participate in regulated markets, we understand that the likely course of action to most of the companies on Unlisted is to revert to traditional OTC trading in the event that Unlisted is no longer able to function in its current form. We cannot see that this would be good for investors or companies. Further, even if the Minister s observation was correct, there is no link between it and the Minister s conclusion that this is detrimental to the integrity and effectiveness of securities markets in New Zealand. Unlisted offers a good low-cost first listing facility to companies. We believe this is particularly important in a country like New Zealand, which is heavily dominated by small SME s for whom capital raising options are limited. At seminars organised by NZAX it was estimated that the incremental cost per annum of meeting increased compliance costs of listing on NZAX (including CEO and CFO time) is likely to be in the order of $300,000 to $500,000 per annum Institute of Finance Professionals New Zealand Inc. UNLISTED 4

5 compared to not listing. Capitalised, this is as much as $4m of a company s market capitalisation. We expect many companies with market capitalisations of $20m to $50m will find this prohibitive (from a cost/value and time perspective). It may be a cost worth accepting if you are trying to raise money and the regulatory commitment demanded by your investors is that of the NZAX. However, if this is not the case or, say for example, you were an existing company with multiple shareholders and you simply wanted to give them some liquidity compared to their current status (ie almost no liquidity), then something like Unlisted seems a very appropriate alternative. We believe that giving companies and shareholders a range of options about the formality, regulation and cost of their trading options based on their individual requirements and preferences is a good thing. Having niche markets around the fringes of the mainstream (high cost, low risk) NZSX/NZAX options seems an enlightened and mature development in New Zealand s securities markets. We point out that investors are no more exposed to investment failure on the Unlisted facility than they are on the NZX or NZAX. Further, NZX listing does not, ipso facto, protect against investment failings and we point to Wakefield Hospital Ltd and Vertex Group Holdings Ltd where the Securities Commission undertook investigations and to the failure of Fortex Ltd. In conclusion, we believe Unlisted is a welcome addition to the New Zealand securities landscape in facilitating price discovery, liquidity and efficient capital raising to a small segment of the market, the counterfactual for which is traditional OTC trading. We do not accept that the Minister has shown the integrity and effectiveness of securities markets or the confidence of investors in those markets is being detrimentally affected by the existence of Unlisted. Given this, rather than regulating Unlisted out of existence, we believe a more reasonable approach to address the Minister s concerns would be to work with Unlisted to ensure that all reasonable steps are being taken to ensure that Unlisted and brokers trading on Unlisted disclose adequately the buyer-(and seller)-beware nature of the trading facility to those trading. Institute of Finance Professionals New Zealand Inc. UNLISTED 5