NZ markets emerge unscathed by regulation, but risks remain
Govt got stuck in on reviews but investors’ fears proved needless
Investors faced 2019 with trepidation as they pondered what might lie ahead for the rules surrounding some key sectors. “Regulatory risk is front and centre for a number of our largest listed companies in 2019,” one Auckland fund manager said at the time.
As it turned out, investors need not have been so worried, as the sharemarket went on to produce another record-breaking run.
High on the agenda at the start were the results of potentially farreaching industry reviews covering telecommunications, fuel, dairy and banking.
In aviation, the Commerce Commission completed its final report.
A number of other reviews were completed — fuel for example — but there is some unfinished business on the regulatory front going into 2020, an election year.
“The next thing is, if the Labour Government is re-elected for a second term, they might start accelerating that process,” Harbour Asset Management portfolio manager Shane Solly said.
“It’s fresh, it’s live, and that’s one of the things that we will be thinking about as investors over the next 12 months,” Solly said.
In some cases the residual uncertainty for businesses and investors comes down implementation of the reviews’ findings — the degree to which the Government wants to act on the findings and how fast, he says.
“Investors will be watching to see if the Government announces another series of reviews, given there was a long list of potential review topics,” Solly said.
Looking ahead, Solly said investors were likely to refocus on the risk of regulation as next year’s general election approaches.
Capital gains tax
The risk: Concerns about the structure, fairness and balance of the tax system led the Tax Working Group to recommend a capital gains tax. The group, led by former finance minister Sir Michael Cullen, said the tax system had many strengths but that there was a clear weakness caused by the inconsistent treatment of capital gains. What happened: In April, the coalition Government said it would not proceed with the group’s recommendation. Prime Minister Jacinda Ardern said she believed there were inequities in the tax system that a capital gains tax would have helped to resolve.
It’s an argument Labour has made since 2011. “However after almost a decade campaigning on it, and after forming a government that represented the majority of New Zealanders, we have been unable to build a mandate for a capital gains tax,” she said.
“While I have believed in a CGT, it’s clear many New Zealanders do not.”
Bank capital
The risk: The Reserve Bank has been reviewing bank capital rules since early 2017. The risk was that the banks would need to lift the amount of capital they hold, with the Reserve Bank giving them five years to fall in line. What happened: The Reserve Bank softened its stance a little — lengthening the phase-in period to seven years, and broadening its definition of tier one capital.
The key decisions, which start to take effect from July 1, 2020, include banks’ total capital increasing from a minimum of 10.5 per cent now, to 18 per cent for the four large banks and 16 per cent for the remaining smaller banks. The average level of capital currently held by banks is 14.1 per cent. The share prices of all the big banks — ANZ, NAB, CBA and Westpac, rallied after the Reserve Bank’s announcement.
Airport regulation
The risk: More stringent rules over price setting at airports.
What happened: Auckland International Airport, the country’s biggest airport, accurately read the tea leaves early in the year and backed down on pricing in the current five-year period, deciding to cut charges by $33 million, dropping its target return from 6.99 per cent to 6.62 per cent.
Commerce and Consumer Affairs Minister Kris Faafoi had become increasingly frustrated with the airport’s stance. Jawboning worked then and airports are worried about legislative changes pending in 2020 which include combining the Civil Aviation Act and Airport Authorities Act into one statute which will include doing away with the power of airports to charge as they see fit. Airlines have welcomed that but there is uncertainty about the practical impact of doing away with the wording and it may also be a scramble to get the law passed in what is shaping up to be a busy election year.
Fuel
The risk: The Commerce Commission undertook a retail fuel market study to establish whether Kiwis were paying a fair price at the pump, the risk being that the Government would regulate the market.
What happened: The market study confirmed the fuel industry was not as competitive as it should be — and that Kiwis pay too much for petrol. The Commerce Commission recommended a raft of new regulations aimed at increasing competition in the wholesale fuel market and driving petrol prices down. “As a result of our study, we consider many fuel companies have been making persistently higher profits over the past decade than we would expect in a competitive market,” Commission Chair Anna Rawlings said.
The commission believed the core problem was that an active wholesale market for fuel does not exist. The Commission recommended introducing a Terminal Gate Pricing Regime, based on the Australian equivalent. This requires all importers to offer a spot price at which they will sell fuel to wholesale customers at storage terminals.
Fuel pipeline
The risk: A government inquiry into the September 2017 pipeline outage and the resilience of the fuel supply to Auckland found that there was an urgent need to build jet fuel resilience at Auckland airport.
What happened: The report recommended building new fuel storage facilities near Auckland Airport and legislation to allow the Government to step in if required. The Marsden Point to Auckland pipeline supplies almost all of Auckland’s diesel and petrol. Three major fuel companies (BP, Mobil, and Z Energy) control, or have exclusive use of the pipeline through a series of joint ventures and commercial agreements.
Telecoms
The risk: The Commerce Commission is in the process of developing and implementing a new regulatory regime for fibre broadband networks. The risk is the sector will be regulated in much the same way as other utilities.
What happened: As a result of changes to the Telecommunications Act, the Commission is required to regulate fibre providers Chorus, Northpower Fibre, Ultrafast Fibre, and Enable Networks to ensure fibre internet services are delivered to New Zealanders at an appropriate price. The new regime will apply from the beginning of 2022.
For Chorus, the regulation takes the shape of a revenue cap, which will limit the prices consumers pay for broadband, as well as minimum standards for things like service availability and network performance. Chorus and the other local fibre companies will also be required to publish performance measures, such as profits, quality of service, and expenditure. This is known as “sunlight regulation”.
The Commission is currently consulting on its draft decisions for the rules, requirements and processes underpinning the new regulatory regime. This includes the allowed rate of return and the value of the assets on which providers can earn a return. The Commission has also made draft decisions on the service quality dimensions that we will measure providers’ performance against. The Commission is also creating safeguards to protect consumers as New Zealand transitions away from the copper phone and broadband network.
Dairy
The risk: Changes to the regulations that govern New Zealand’s dairy industry DIRA, and allow dairy co-op Fonterra to operate as a near monopoly.
What happened: A review of the Dairy Industry Restructuring Act
2001 (DIRA) and its impact on the dairy industry was announced in December 2017. Public consultation and meetings finished in February this year.
Fonterra wants an end to the coop’s open entry and exit provisions, more control over new conversions, changes to raw milk regulations and transparency around the milk price for all processors. The Dairy Industry Restructuring Amendment Bill had its first reading on August 27, 2019, and is now before the Primary Production Select Committee, which is to report the Bill back to Parliament in March
2020.
Electricity
The Risk: Still more regulation for an already highly regulated sector. The Electricity Price Review was part of the coalition deal between Labour and NZ First, which promising a “fullscale review into retail power pricing”.
What happened: The centrepiece of the wide-ranging package was a proposal to scrap the discounts that most power companies offer to customers who pay promptly. The discounts can be up to 20 per cent on an average household power bill of $173 a month, or about $34.
The Electricity Price Review Group recommended that the Government should regulate to prohibit prompt payment discounts, although still allowing late payment fees as long as they reflect the actual costs of recovering debts. Energy Minister Megan Woods declined to regulate immediately. Apart from scrapping prompt payment discounts, the package included several measures to make it easier to switch between power companies to get the best deal.
Changes to ETS
Just before Christmas, the Government announced potential changes to the emissions trading scheme (ETS), which farmers said could accelerate the purchase of productive land for the conversion into forestry if implemented.
Federated Farmers and BusinessNZ also hit out at the short, two-month, window for submissions to the proposals. The Government proposed lifting the current fixedprice option by $10 to $35 a tonne for emissions produced in 2020, but then replacing that with an auction floor price of $20 a tonne and a cap at $50. The consultation period finishes on February 28.
Farmers said doubling the carbon price cap to $50 per tonne will accelerate the purchase of productive pasture land for blanket pine forest “carbon farming”.
Harbour Asset’s Solly said businesses would need to take another look at the whole carbon issue in 2020. “There will be some winners and losers, but in the long run it will be important for businesses to get on top of this.”
What’s next?
Craigs Investment Partners head of private wealth research Mark Lister said there will always be an element of regulatory risk in New Zealand, with its high number of utilities and pseudo monopolies, and generally less competition than bigger economies.
Sectors such as electricity and airports are always going to be in the firing line. The same goes for the fuel industry and the banking sector, he says.
“We have felt the regulatory presence of that across the whole market, but it has not at all been a stumbling block for the share market, which has had its best year of all time.”
For some sectors, the risk of regulation has weighed on sentiment.
“The banking sector is probably the one that has come off the worst in terms of the changes that they have faced.”
On the fuel industry, little has come from its regulatory review.
Petrol retailer Z Energy has seen its share price come under pressure but not from possible law changes.
Z Energy last week forecast a reduction in operational performance for December and the final quarter of 2020 due to the negative impact of low refining margins and continued price discounting in the retail fuel market.
“Z Energy is facing its own issues outside of what you have seen on the regulatory front. I’m not sure if they can blame the regulator for the slump in their share price,” Lister said.
Every time there is a new government there is a look at the electricity industry because it’s such an easy one to score cheap political capital out of, he says.
“The truth is that it is pretty wellrun, well-regulated industry and there is lots of competition.
“Not a lot of improvement can be made there,” he says.
The power companies have come through the regulatory risk period largely unscathed.
While Auckland Airport looked to compromise in the face of regulation, Lister pointed out that just half the company’s earnings come from aeronautics.
On the Government’s backdown on capital gains tax, Lister said the tax would have affected a range of businesses from anyone involved in the property sector to the market overall.
“All up, the regulatory risks are always going to be there because of the nature of our market and our small economy, but compared with where we were a year ago, the regulatory risks have subsided,” he said.
“We have seen some of those studies take place and the repercussions have been negligible or less draconian than they could have been.”
“We can tick off the banking sector, the electricity sector, and the airport sector for now.”
Fuel, to a degree, is behind us. “I would say the regulatory risks are always bubbling away in the background but on a short term basis, there is probably less to be concerned about than when this government first took office.”