ASX announcement - ASX Demutualisation – The First Four Months

18 February 1999

Address by Richard Humphry, Managing Director, Australian Stock Exchange to CEDA, Melbourne

Four months ago last weekend, ASX made the revolutionary move of changing itself from a mutual organisation of stockbrokers to a shareholder-owned public company. The following day it listed on its own market and its shares were quoted. This was truly revolutionary, because although a handful of other exchanges had taken the first step of demutualising, none had listed. I don’t count the case of Stockholm, which demutualised and later became a subsidiary of a company that was already listed.

This change of structure was much more than cosmetic. It meant a revolution in the way ASX approached both its functions and its customers. As the first paragraph of our information memorandum put it, we changed from an organisation structured primarily to serve its stockbroker members to a company with a clear commitment to generating competitive returns for its shareholders while having regard to the interests of all its customers and those of the broader economic community. The new structure also had the important effect of separating the right of access to ASX’s markets from ownership of ASX. That has enabled ownership to expand from the initial 606 shareholders, who were our former members, to more than 6,000 – and of those more than 5,000 shareholders have fewer than 5,000 shares each.

Some sections of the media, as I’m sure you are aware – cartoonists as well as journalists – have become obsessed with the original 606, and how much their shares are worth (if they still hold them). The same story is trotted out every time ASX shares rise significantly on the market. I must confess I find this obsession hard to explain, other than by simple envy, or trying to stir up the envy of readers. After all, there’s no difference in principle between ASX issuing shares to its members and AMP issuing shares to its policyholders. In both cases they were effectively the owners. I wasn’t being Father Christmas.

The difference lies in the relatively small number of ASX members who shared in the value that the market placed on the company, but that is simply a function of the specialised organisation that ASX was and is. Stock exchanges in Australia aren’t a closed shop – they ceased being that in the early 1980s, when the system of a fixed number of tradeable seats was abolished. Since then, any qualified organisation or individual could become a member by paying a membership fee of $250,000 or $25,000 respectively. The number of 606 at the time of demutualisation simply reflected supply and demand in the stockbroking industry, and the desire of qualified people to be members.

No-one had any idea what the market would value ASX’s shares at when they were quoted, because there is no closely similar company on the market for comparison. Analysts in stockbroking firms did some sums and published estimates in a range of $3.50 to $5, which turned out to be quite accurate overall when the shares ended their first day’s trading at $4.25. That meant the 166,000 shares issued to each former member were worth just over $700,000. That’s not really such an outrageous figure, when you consider that the price of a seat on the Sydney Stock Exchange reached $87,000 in 1970, which equals $600,000 in today’s dollars. And that bought you a share of the assets of the Sydney Stock Exchange only, whereas the $700,000 represented a share of the assets of the former exchanges in all six states.

Since our shares were quoted they have risen in value quite spectacularly, to a peak of $12.20 on February 5. That valued the company at nearly $1¼ billion. It is not clear why the market places that value on us. It could reflect a number of factors, ranging from a shortage of sellers, through our inclusion in the All Ordinaries Index, to the fact that we are talking to the Sydney Futures Exchange about the possibility of merging our businesses. Some part of the increase is no doubt due to the fact that we have been enjoying a much more favourable market environment than was foreseen before we listed.

If you look at what’s happened to the market over the past couple of years, one of its outstanding characteristics has been volatility. When we decided that our listing information memorandum ought to contain projections of our business for the current financial year, there wasn’t an obvious trend to follow. What we projected for activity in our major market, the equities market, was approximately the average level since the beginning of 1997. We also provided a table showing how sensitive our revenue was to business volumes. As it turned out, the level of equities market activity from August to December has been far above the projected level – nearly 20 per cent above, in fact. That has been reflected in our other business activities as well.

It is one of the peculiarities of being a highly automated stock exchange that we have a very high proportion of fixed costs, much of it in computer and communications equipment, and a correspondingly low proportion of variable costs. The result is that, above a certain level, increased trading volumes in our markets don’t just flow through to revenue, they largely flow through to profit. In percentage terms, of course, the effect on profit is much greater. We aren’t like a company producing jars of jam, where production costs move in lockstep with sales. That is why we were so careful to keep the market informed about trading volumes before and after our listing.

You may recall that, the day before we listed, we provided actual levels of activity in our major business segments and compared them with the assumptions used in the information memorandum. We wanted to be sure that, when our shares were quoted and a price for them was established, it was done on the basis of the most up-to-date possible information. We did the same thing a month later, when continuing high levels of market activity indicated that our half-year profit to December 31 could be about double that implied in the information memorandum.

A very high level of activity has continued into the first weeks of 1999. What does it mean in terms of future activity levels? I really haven’t the faintest idea. It could be heralding the last days of Pompeii, or it could mean that the market is finding a new and higher normal level of activity. We’ll only know that in hindsight.

Apart from the increased wealth of our former members, the other theme that has been running through the media over the past four months is that ASX has become more commercial since its demutualisation, often with the implication that this is somehow a bad thing. It is certainly true that we are more commercial, but it is no bad thing and I make no apology for it. The fact is that a mutual organisation is not meant to be commercial. It isn’t allowed to distribute profits to its members, so its only reason for making a surplus at all is to fund future development. Apart from that, it is supposed to provide services to its members as efficiently and economically as possible.

ASX did that while it was a mutual, and this mean that some of our services were substantially underpriced, particularly those directed principally at stockbrokers. That simply isn’t a proper basis for operating a shareholder-owned company. It had to change, and it did change.

But there are other changes that have taken place in our market that are far more significant than that. I want to mention three of them – two relating to the market that began before demutualisation, and one very important change that has resulted from it.

First, there has been a radical change in the composition of the Australian stock market. At the beginning of this decade, resources were the largest sector of the market, followed by the traditional industrial sector based on manufacturing, with the services sector (including finance) last. Today the services sector is dominant, representing some 60 per cent of market capitalisation. Traditional industrials account for 24 per cent, and resources for just 16 per cent. That does reflect in part the current cyclical low in commodity prices, but it is also a reflection of the profound way in which Australia has changed over the decade of the 1990s.

It’s interesting, though, that in dollar terms the resources sector is worth more today than it was at the start of the decade, because of the spectacular growth of the whole market. At the beginning of 1991, the resources sector was worth $66 billion, whereas today it is worth $86 billion, which even in real terms is a 10 per cent increase. But the whole market has grown from $180 billion to $550 billion, which is a 150 per cent increase in real terms.

That growth rate has been good enough to make us the second largest stock exchange in the Asian region, after Japan. Hong Kong was bigger than us for a while, but we’ve overtaken them again. That’s good, but it’s sobering to take a broader view and look at our position in the wider world. Then we’re almost invisible, with just 1.2 per cent of world capitalisation. The stock exchange world is dominated by the United States, which alone accounts for more than half the world capitalisation as measured by the Morgan Stanley Capital International index, and Europe with more than a third. When you allow for Japan’s 10 per cent, that leaves the rest of us with just 2.6 per cent to share around. In this larger pond we are indeed a small fish. That is one reason why we have been busy forging co-operation agreements with stock exchanges in Asia, and why we are now talking to Nasdaq about possible areas of co-operation.

The other major change that has taken place in the market is in the composition of investors. When we undertook a survey of share ownership back in 1988, we found that just 9 per cent of adults, or 1.1 million people, had any investment in the share market. That has grown steadily to a point where in October last year more than 40 per cent of Australian adults had share investments, which means 5.5 million people. Eighty per cent of them had direct shareholdings, and the rest invested through managed funds. That is nothing less than a social revolution, and it should be a strong underpinning for the free-market approach that has done so much for Australia’s economic growth.

Perceptions of share investment have also changed radically. For nearly two decades it was regarded by the public as the least wise place to put savings. That perception started improving at the start of this decade, and in June last year shares finally came to be seen as the wisest place of all to put your savings. That is an accurate perception, because the stock market has been the best performer over the long term, with compound returns of 11 per cent a year for the past century.

The third change is the one that has resulted from demutualisation, and it may turn out to be the most significant of all. It is an attitudinal change, and it is still under way. We had quite a reasonable time to prepare for demutualisation, and when it came I believe we were intellectually prepared for it. I am not sure that we were behaviourally or emotionally prepared, which is understandable because these always take longer to change.

ASX has always prided itself on its high standards – its technical excellence, its responsibility, its integrity. Those are vital attributes for a stock exchange, whose competitive position is so dependent on the integrity of its markets, and they are reflected in such things as the listing rules and the business rules, and the way compliance with them is supervised. But for a commercial enterprise that is an incomplete set of necessary attributes. What it omits is an acute consciousness of what the customer wants.

Once again that is understandable, because in a sense a mutual organisation only has one group it is responsible to – in our case, stockbrokers. That leads to a focus on doing what is perceived to be necessary, rather than a focus on the effect of what you do on customers. If we believed that corporate governance needed a boost, we’d change the listing rules to achieve that. We would consult with interested parties, but ultimately we would do what we thought best whether our affected customers, in this case listed companies, wanted it or not. That isn’t the root cause of all the headlines we get, however. Sometimes those we did consult with turned out not to be representative of the relevant customer group as a whole, as was the case with recent changes to the All Ordinaries Index.

I am not suggesting that we should not have brought in a listing rule for corporate governance disclosure or made very necessary changes to the All Ordinaries. What I am saying is that, when we are going to do such things as a commercial organisation, we need to go to much greater lengths in the consultation process. Understandably, customers tend to see only the disruptive effect of change on themselves, and not the objective need for change. That can require a lot of explanation. In a well-worn saying, we now have to put our customers first, subject always to our responsibilities as a quasi-regulator. We know very well that is the case, and our attitudes and behaviour are changing to incorporate that knowledge.

Yes, ASX is certainly more commercial than it used to be. If we hadn’t become commercial, and started considering the needs of all our customers instead of one small group of them, you would have to wonder how long we could have survived in an era of global competition. The U.S. stock market is telling us that the first decade of the new millennium is going to be the decade of the Internet. We are already seeing virtually straight-through ordering from investors to the market, here in Australia as well as in the U.S. It can’t be long before that becomes common across national borders as well. When that happens, it will be a case of survival of the fittest. With our new commercial focus, we aim to be one of those survivors. It may be that we demutualised just in time.