The Australian Government established a Royal Commission into Misconduct in the Banking, Superannuation and Financial Services industry in December 2017. The Commission was launched in response to a series of allegations made over the past few years including fraudulent lending, interest rate rigging, providing inappropriate financial advice and retaining customer benefits. The hearings are ongoing, and uncertainty regarding potential outcomes for the banks and their profits remains. This is reflected in the share price performance of the major banks, which have underperformed the ASX200 index since the Commission was announced. AMP saw a more severe share price reaction when financial penalties were levied in response to the Royal Commission findings that it charged customers fees for no service.
This is an extreme example of the impact of regulatory uncertainty on share prices. Examples closer to home include the collapse of the Chorus share price in 2012 and 2013, when the Commerce Commission was in the process of re-setting the price for access to its copper lines, and the underperformance of the electricity companies in the run up to the 2014 general election due to the Labour/Greens proposal to create a single buyer of wholesale electricity.
In the last six months, a number of new regulatory studies have been launched in New Zealand:
- Retail Power Price Review: to investigate whether the electricity market is delivering efficient, fair and equitable prices to end consumers.
- Fuel Market Study: To provide evidence for a stronger case that retail fuel prices and margins are unreasonable.
- Mobile Market Study: To gain a better understanding of how mobile markets are performing and developing, and to consider whether any regulatory measures are appropriate.
These studies will directly impact New Zealand companies with a combined value of nearly $30bn, or approximately 28% of the New Zealand share market.
Regulation is important to control prices and service in markets where there is limited competition and consumers have few options to switch to alternative providers. However, changes in regulation create uncertainty, particularly if prices and profits could fall. This uncertainty discourages investment, both at company level and from shareholders with other investment options.
Given these reviews impact a sizable proportion of the New Zealand share market, this uncertainty could drive underperformance of the New Zealand market while they are underway. An outcome from any one review that negatively impacts company earnings will likely make investors more nervous as to the outcomes of the other reviews, despite them being entirely independent of each other. This risk is elevated by the relatively high proportion of offshore ownership in our market, at close to 50%. Offshore investors may be more willing to re-allocate capital to other markets with lower perceived regulatory risks.
Of course, uncertainty and share price volatility create opportunities for active managers. We will follow the progress of these reviews closely and be ready to act upon the conclusions drawn. Returning to the Chorus example, its share price increased 83% in 2014 following a favorable outcome of the copper access price review.
However, it is important the review timelines are met (conclusions are expected from late-2018 to mid-2019) as in the meantime, investors will likely require a higher return for the elevated risk profiles of these companies.