20101206 ASX SGX AccessReport

Commercial-in-Confidence

ASX-SGX: why the combination is in Australias national interest

6 December 2010

Report by Access Economics Pty Limited for

ASX Limited



Access Economics Pty Limited

This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Permission for any more extensive reproduction must be obtained from Access Economics Pty Limited through the contact officer listed for this report.

Disclaimer

While every effort has been made to ensure the accuracy of this document and any attachments, the uncertain nature of economic data, forecasting and analysis means that Access Economics Pty Limited is unable to make any warranties in relation to the information contained herein. Access Economics Pty Limited, its employees and agents disclaim liability for any loss or damage which may arise as a consequence of any person relying on the information contained in this document and any attachments. Access Economics Pty Limited ABN 82 113 621 361 www.AccessEconomics.com.au

CANBERRA MELBOURNE SYDNEY Level 1 9 Sydney Avenue Barton ACT 2600

Level 27 150 Lonsdale Street Melbourne VIC 3000

Suite 1401, Level 14 68 Pitt Street Sydney NSW 2000

T: +61 2 6175 2000 F: +61 2 6175 2001

T: +61 3 9659 8300 F: +61 3 9659 8301

T: +61 2 9376 2500 F: +61 2 9376 2501

For information on this report please contact Professor Ian Harper [email protected] 03 9659 8300

Declaration Neither Access Economics Pty Ltd nor any Director or staff member who prepared this report holds shares directly in ASX Limited.



Contents

Executive Summary .................................................................................................................... i

1 Introduction .................................................................................................................... 1

1.1 The proposal ..................................................................................................................... 1

1.2 The national interest tests ................................................................................................. 2

1.3 Approach to the analysis ................................................................................................... 3

1.4 Contents of this report ...................................................................................................... 4

2 Australia as a Regional Financial Services Hub ................................................................. 6

2.1 Unrealised potential.......................................................................................................... 6

2.2 Significance of ASX-SGX ..................................................................................................... 8

3 Reduced Cost of Capital ................................................................................................ 11

3.1 Reliance on foreign capital .............................................................................................. 11

3.2 Significance of ASX-SGX ................................................................................................... 17

4 Opportunities for Diversification ................................................................................... 22

4.1 Comparing ASX and SGX .................................................................................................. 22

4.2 Significance of ASX-SGX ................................................................................................... 28

5 Regulatory Control ........................................................................................................ 30

5.1 Impact of ASX-SGX .......................................................................................................... 30

5.2 Regulation and financial services in Australia and Singapore ............................................ 31

6 Illustrative Examples of New Services and Opportunities ............................................... 36

6.1 Benefits for the Australian funds management industry .................................................. 36

6.2 New products and services .............................................................................................. 37

6.3 Passport listing and secondary market quotation ............................................................ 38

6.4 Improving efficiency for the market and its participants .................................................. 39

6.5 Improved distribution of existing products and services .................................................. 40

7 The Counterfactual ....................................................................................................... 42

8 Conclusions ................................................................................................................... 48

References .............................................................................................................................. 49

Appendix A : Ten economic reasons why the ASX-SGX merger proposal should be approved .. 52

Appendix B : Reliance on foreign capital .................................................................................. 65

Appendix C : Recent examples of exchange mergers ............................................................... 69

Charts

Chart 2.1 : Overview of key financial centres ............................................................................. 9

Chart 3.1 : Australias current account deficit since Federation (% of GDP) .............................. 12

Chart 3.2 : Australias net foreign liabilities (% of GDP) ............................................................ 14

Chart 3.3 : Australian exports versus stock of foreign direct investment .................................. 16



Chart 4.1 : Market concentration of the largest 5% of companies by market capitalisation ..... 23

Chart 4.2 : Domestic market capitalisation by size segment .................................................... 24

Chart 4.3 : Number of domestic companies by size segment ................................................... 25

Chart 4.4 : ASX and SGX sectoral representation (proportion of market capitalisation) ............ 26

Chart 4.5 : ASX and SGX have complementary strengths ......................................................... 28

Chart 7.1 : Proportion of turnover in ASX-listed securities outside of the Central Limit Order Book ...................................................................................................................... 43

Chart 7.2 : ASX, NZX and LSE market share (% of global market capitalisation) ........................ 44

Chart 7.3 : ASX, NZX and LSE market capitalisation ($US billions)............................................. 45

Chart 7.4 : ASX, NZX and LSE number of listed companies ....................................................... 46

Chart B.1 : Gross investment (% of GDP, previous decade) ...................................................... 66

Chart B.2 : Australian engineering construction work (% of GDP) ............................................ 66

Chart B.3 : Large and persistent current account deficits (1960-2006) ..................................... 67

Tables

Table 3.1 : Foreign investment in Australia by country/region (stock, $ billions) ...................... 17

Table 4.1 : Major international exchanges ............................................................................... 23

Table 4.2 : Value of share trading of selected stock exchanges, 2009 ...................................... 25

Table 4.3 : Total value of listed bond trading 2009 ($US million) ............................................. 27

Table 4.4 : Derivative products traded on ASX and SGX during 2009........................................ 27

Table 5.1 : World Economic Forum Financial Development Ranking 2010 ............................... 32

Table 5.2 : World Economic Forum Global Competitiveness Report Ranking 2009-10 .............. 32

Table 5.3 : World Bank Ease of Doing Business Rankings 2010 ............................................... 32

Table 5.4 : IMD World Competitiveness Yearbook 2010 .......................................................... 33

Table A.1 : Foreign investment in Australia by country/region (stock, $ billions) ...................... 55

Table A.2 : Australian overseas investment by country/region (stock, $ billions) ..................... 57

Table B.1 : Episodes of deficit reversals ................................................................................... 68

Figures

Figure 1.1 : Assessing the national interest ................................................................................ 3

Figure 2.1 : Exports and imports of financial services ................................................................ 6

Figure A.1 : Australian financial services have weak international links.................................... 53



Glossary

ADR American Depository Receipt

APEC Asia-Pacific Economic Cooperation

ASEAN Association of South-East Asian Nations

ASIC Australian Securities and Investments Commission

ASX ASX Limited

CA Corporations Act

CLOB Central Limit Order Book

ETFs Exchange-traded funds

FATA Foreign Acquisitions and Takeovers Act

FDI Foreign direct investment

FIRB Foreign Investment Review Board

FSDF Financial Sector Development Fund

FUM Funds under management

GDP Gross domestic product

GFC Global Financial Crisis

ICT Information and communications technology

IMF International Monetary Fund

LSE London Stock Exchange

MAS Monetary Authority of Singapore

NZX New Zealand Stock Exchange

OECD Organisation of Economic Cooperation and Development

RBA Reserve Bank of Australia

REITs Real estate investment trusts

SAFTA Singapore-Australia Free Trade Agreement

SGX Singapore Exchange Limited

SMEs Small and medium-size enterprises

WFE World Federation of Exchanges


i Commercial-in-Confidence

Executive Summary

ASX Limited (ASX) has engaged Access Economics to examine the national interest implications of the proposed merger between ASX and Singapore Exchange Limited (SGX). The merger would create a new exchange group ASX-SGX Limited.

The merged group would become the fifth largest securities exchange in the world by market capitalisation (approximately US$12.3 billion), the second largest listings venue in Asia, and the largest provider of exchange-traded funds (ETFs), derivative products and real estate investment trusts (REITs) in Asia.

Analysing the national interest case for approving the formation of ASX-SGX must begin by recognising that the Australian assets of the new exchange group the licences to operate the various exchange functions in Australia do not exist apart from the will of the Australian Parliament.

Exchange groups cannot operate in Australia without valid licences, and they remain subject to government and regulatory agency oversight and Ministerial direction no matter who owns them.

Since the Australian Parliament exists to promote and protect Australias national interest, the fact that the licensed Australian businesses of ASX-SGX only exist if the merged entity abides by the conditions of its Australian licences guarantees that the Australian Government continues to have ultimate sanction over the activities of ASX-SGX in Australia.

Beyond this, the questions of national interest most relevant to the ASX-SGX proposal are economic in nature. The core question, as recognised by the Treasurer, is whether Australias economic prosperity is promoted or adversely affected by the formation of ASX-SGX. This report assesses the national interest implications of ASX-SGX under four headings.

1. Australia as a regional financial services hub

Policymakers have long sought ways of establishing Australia as a regional financial services hub. While regulations and international trade agreements have gone some way towards increasing Australias presence in world markets, further integration with financial markets in the Asia-Pacific would be a tangible and significant step towards promoting Australia as an Asia-Pacific financial services hub.

John Brogden (2010) in his recent article in The Australian entitled Funds Passport is Australian financial players key to Asia identifies the inefficiencies currently evident in cross-border regulations particularly in reference to the financial services sector which denies our investment products access to our own region *Asia+ and vice versa. The key barrier to Australias financial services entering Asian markets is the relative inability of an Australian fund manager to obtain a financial services license in most Asian countries. To counter this significant competitive drawback, Brogden supports the introduction of the proposed Asian Region Funds Passport.

Australia has many attractive qualities as a market for financial services a skilled and mobile workforce, political stability, and a sound legal and regulatory framework, plus one of the worlds largest pools of funds under management, a strong banking system and world-class


ii Commercial-in-Confidence

exchange infrastructure but these have not yet translated into significant cross-border activity. Australias low level of exports and imports of financial services is just one indicator among many that demonstrate an overly domestic focus. Our ambitions to become a regional financial services hub require stronger connections beyond Australias shores, most especially into Asia.

ASX-SGX will help to build a conduit into Asian financial markets to improve financial flows between Australia and Asia, and connect Australias funds management industry to fast-growing pools of Asian savings.

While Australia does hold a latent comparative advantage in financial services and geographic proximity to a relatively untapped Asian market, our financial markets still tend to suffer from low brand recognition offshore and geographic remoteness from most major centres. Without some physical presence closer to the Asian mainland, Australia will compete with other Asian financial centres for market access, the most prominent of which are Singapore and Hong Kong.

ASX-SGX has huge potential to offer Australian businesses easy access to deep, liquid and diverse sources of capital. ASX and SGX have already revealed their intentions to develop a range of new non-A$ products and services, a move that would prove difficult if the exchanges remained separately owned. Cross-listing, cross-membership and mutual offset arrangements between the two exchanges will enable ASX listings to obtain enhanced profile in Asia and better exposure to Asia-based investors.

ASX-SGX will raise the profile of Australias financial markets within Asia and beyond.

2. Reduced cost of capital

Australias standard of living owes much to our ability to attract and effectively use foreign savings. Access to overseas capital has helped foster higher rates of economic growth, develop new industries and infrastructure, and strengthen trade and economic links with the rest of the world. Indeed, a reliance on foreign capital has been a prominent long-term feature of Australias economic development given the limited size of our own capital markets and the dominance of capital-intensive industries, especially mining.

Key characteristics of Australias economic circumstances include:

a reliance on foreign funding that is likely to increase, and to be increasingly affected by developments in China and India major importers of Australian resources; and

domination of foreign capital inflow by short-term bank debt, as Australias domestic banks are the major source of debt capital for Australian corporates and individuals.

The availability and pricing of equity capital is facilitated by securities exchanges. Given that issuers and market participants will gravitate over time to the exchange with the most capital and the most cost-effective and speedy settlement and registration, Australia needs to be on the right side of those trends.


iii Commercial-in-Confidence

Conceptually, the greater the size, liquidity, and reach of an exchange, the more cheaply it can assemble capital from investors, and the better it can match the risk and reward preferences of investors and companies. While the precise impacts of cross-border exchange mergers are still unknown, a recent study by Nielsson (2009), which investigated the impact on market liquidity of forming the Euronext exchange, noted that the main motivation for studying liquidity is that it ultimately affects the cost of capital.

ASX-SGX has the potential to:

increase access to foreign capital; and

lower the cost of capital through increased scale, liquidity and diversification.

Given the dependence of Australias economic prosperity on continuing access to foreign capital, any proposal that increases access to and reduces the cost of foreign capital to Australia must be in the national interest.

ASX-SGX is a natural fit for encouraging Asian capital to invest in Australias economic potential.

3. Opportunities for diversification

ASX and SGX are sufficiently different yet sufficiently similar to offer scope for diversification across regions, markets and sectors to Australian savers and investors.

ASX-SGX will create opportunities for Australian savers to diversify their asset holdings more easily across Asian investments; and for Australian issuers to broaden their sources of capital to include the rapidly growing pool of Asian savings. As Brogden (2010) notes:

Asias population is 4.2 billion (60% of the worlds population) and is expected to grow by 17% by 2050.

Many Asian countries have established pension schemes to help fund the ageing of their populations.

Asia will generate much of the worlds wealth over coming years. Consensus forecasts indicate that China and India will grow at double the rate of the rest of the world in the five years to 2015.

However, at this stage, Asia has just 13% of the worlds funds under management (or about $10 trillion based on 2007 figures for global funds under management (IFSL 2009)).

Both Australia and Singapore are internationally regarded as safe and strong financial centres. Key complementary features of ASX and SGX include:

Comparable vertically integrated business profiles (i.e. offering trading, clearing and settlement services) plus strong legal rights and investor protection mechanisms.

ASX is dominated by financial stocks, especially banks, and listed mining companies. SGX, on the other hand, is dominated by industrial and materials companies,


iv Commercial-in-Confidence

information and communications technology (ICT) stocks, real estate investment trusts (REITs) and financial stocks.

Bond trading is far more established on SGX than ASX, with the value of bond trading on SGX more than 15 times that on ASX in 2009 (WFE 2009).

ASX has a wider array of derivative products available to market participants compared to SGX. However, SGX offers a suite of regional index futures contracts covering the Chinese, Japanese and Indian markets, whereas ASX lists only one domestic stock index futures contract (based on the S&P/ASX 200 index).

The complementary nature of the ASX-SGX transaction is evident in the chart below, which compares the relative strengths of the two exchange groups. Clearly the exchanges are almost perfectly matched in terms of their sectoral profiles. The merged group will have a more balanced profile than either ASX or SGX separately, with flow-on implications for market risk.

0% 20% 40% 60% 80% 100%

Auto, Industrial Goods, Food and Personal Goods (by market cap)

Travel & Leisure (by market cap)

Real Estate (by market cap)

Technology & Telecom (by market cap)

Financials (ex real estate) (by market cap)

Basic Resources (by market cap)

Energy and Utilities (by market cap)

Bond trading (by value, 2009)

Range of derivative products (number, 2009)

ASX SGX

Source: WFE, Bloomberg.

Overall, broader diversification benefits are offered to Australian savers and investors as ASX-SGX builds a conduit between the two complementary exchanges and opens opportunities for participants in both markets to broaden their horizons. This will diminish home country bias in both markets, potentially lowering the cost of capital as savers and investors diversify their holdings across the two markets.


v Commercial-in-Confidence

4. Regulatory control

The Australian operations of ASX-SGX will continue to be regulated by ASIC and the RBA with Ministerial oversight, and an Australian board with an Australian chair will continue to oversee Australian operations. There is no loss of regulatory authority or oversight of exchange operations in Australia implied by the merger of ASX and SGX just as there has been no loss of regulatory oversight by domestic regulators in the many other cross-border exchange consolidations.

In addition, there is no reason to be concerned about Singapores regulatory environment. Independent international institutions (such as the World Bank, the IMF and the World Economic Forum), which assess a broad sweep of institutional features bearing on financial systems, rate both countries highly. Singapore and Australia are well matched with regard to regulatory standards and investor protection.

The counterfactual

ASX should be allowed to respond to new competitors entering its markets.

In March 2010, the Australian Government announced its support for competition between exchanges for trading in ASX-listed products in Australia. These developments have opened the door for the foreign-owned operator, Chi-X, to enter the Australian exchange market. Policy makers expect that competition in trading of ASX-listed stocks will lower transaction costs and improve product and service innovation for users.

ASX will face increased domestic and international competition in any case even if ASX-SGX does not proceed. ASIC is preparing Australias equity market regulatory framework to encourage greater competition. Disallowing ASX-SGX would rule out a rational strategic response on ASXs part to its changing market environment, changes facilitated by the Australian regulatory authorities, which have oversight of ASXs compliance with its own licence obligations.

Furthermore, the current regulatory framework does not prohibit foreign ownership of ASX and proposes no foreign ownership limitations on new market operators that will compete against ASX. In contrast to the controlled way in which the ASX-SGX merger is currently proposed, the ownership of ASX could transition to foreign investors over time and in a less strategic fashion.

Finally, if ASX-SGX were disallowed, this could add to perceptions, especially in Asia, that Australia is not welcoming of foreign investment and/or is overly protectionist.

Conclusions

This report finds that the proposed formation of ASX-SGX is not contrary to Australias national interest and, moreover, is consistent with Australias national interest since: (i) ASX-SGX will improve the economic welfare of Australians; and (ii) the ASX will continue to operate in Australia and be regulated by Australian authorities.


vi Commercial-in-Confidence

Moreover, SGX stands out as the most logical merger partner for ASX given that (i) the bulk of future capital flows into Australian investment projects will come from Asian savings (and investors); (ii) ASX and SGX are complementary, meaning that there is not one dominant business in the proposed merged group; and that (iii) ASX and SGX have similar business models, common technology, and complementary sectoral representation.

Access Economics


1 Commercial-in-Confidence

1 Introduction

ASX Limited (ASX) has engaged Access Economics to examine the national interest implications of the proposed merger between ASX and Singapore Exchange Limited (SGX). The merger would create a new exchange group ASX-SGX Limited.

A securities exchange is quite different from a mining company or an agricultural business. Their prime assets the mineral deposit being mined or the land being farmed are geographically fixed and exist naturally, quite independent of the will of government. The key business franchise of an exchange group, on the other hand, is made up of its licences to operate trading, clearing and settlement facilities. Those facilities are provided by technology platforms that operate within a domestic regulatory framework. The Australian regulatory framework is set by Australian law and overseen by government and its responsible regulatory agencies.

In this sense, securities exchanges are a means to an end rather than an end in themselves. They are of value to a community because of the function they perform. Unlike mineral deposits or fertile agricultural land, which are unique assets and limited in supply, exchange licences can be replicated or changed by governments and their regulatory agencies. A government can decide to have more or fewer licensed exchanges.

Analysing the national interest case for approving the proposed formation of ASX-SGX must begin with the recognition that the assets in question the licences to operate the various exchange functions do not exist apart from the will of the Australian Parliament. The right to continue to operate these functions exists only at the behest of government and its regulatory agencies.

Exchange groups cannot operate in Australia without valid licences, and they remain subject to government and regulatory agency oversight and Ministerial direction no matter who owns them. Allowing a foreign entity, in this case SGX, to acquire the shares of ASX does not distance the combined entity, ASX-SGX, from the authority of the Australian Parliament in relation to the operation of the combined entitys Australian businesses.

Since the Australian Parliament exists to promote and protect Australias national interest, the fact that the licensed Australian businesses of ASX-SGX only exist if the merged entity abides by the conditions of its Australian licences guarantees that the Australian Government continues to have ultimate sanction over the activities of ASX-SGX in Australia.

1.1 The proposal

On 25 October 2010, ASX and SGX announced that they entered into a merger implementation agreement to combine to enable customers globally to capitalise on listing, trading, clearing and settlement opportunities created through the expanded platforms, leveraging on the importance of Asia Pacific as the driver of global growth.1

Currently, both ASX and SGX are publicly-listed companies. Under ASX-SGX, ASX shareholders will be paid $22 in cash and 3.473 new SGX shares for each existing ASX share. ASX-SGX is

1 ASX Media Release, 25 October 2010. http://www.asx.com.au/about/pdf/20101025_asx_sgx_media_release.pdf

http://www.asx.com.au/about/pdf/20101025_asx_sgx_media_release.pdf



structured in this way to compensate ASX shareholders for SGXs higher price-to-earnings ratio and to generate earnings per share accretion for SGX whilst paying a large premium. The deal values ASX at $482 per share, which represents a premium of 37.3% relative to the closing price of ASX shares on 22 October 2010, or $8.4 billion in total.

Subject to regulatory approval, the merged group would have an international board comprising fifteen directors from five countries, including four directors from Australia who would be drawn from the current ASX parent board and include the chairman of the ASX Compliance subsidiary board. Regulation of the relevant exchanges would be shared between Australian and Singaporean authorities, with the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA) regulating the Australian operations and the Monetary Authority of Singapore (MAS) overseeing the Singaporean operations of ASX-SGX Limited.

ASX-SGX Limited would be the holding company for the combined group and would itself be listed on both ASX and SGX. The combined group would continue to operate exchanges in Australia and Singapore, employ approximately 1,100 people and be regulated by their respective local authorities.

Centres of excellence would be created to leverage existing skill sets in both locations. ASX will maintain its regional office presence (in addition to the Sydney head office), with the Perth office to be expanded given its geographic and time zone centrality to the new exchange group.

The merged group would become the fifth largest in the world by market capitalisation (approximately US$12.3 billion), the second largest listing venue in Asia, and the largest provider of exchange-traded funds (ETFs), derivative products and real estate investment trusts (REITs) in Asia.

1.2 The national interest tests

ASX-SGX must pass two national interest tests.

The Foreign Acquisitions and Takeovers Act 1975 (FATA) empowers the Treasurer to prohibit the foreign acquisition of shares in an Australian company if the result would be contrary to Australias national interest.

Division 1 of Part 7.4 of the Corporations Act 2001 (CA) requires a regulation to be made to enable any company (whether foreign-owned or not) to acquire more than 15% of the shares in ASX Limited as Australian cash equities market licensee. It separately requires the Minister to be satisfied that an acquisition resulting in a company having 15% or more voting power in the ASX Group futures market licensee, and clearing and settlement facilities licensees, and their holding companies, is in the national interest before the Minister may approve such an acquisition.

What constitutes Australias national interest is not defined in either Act but it clearly encompasses matters such as defence, national security and foreign relations. While these issues might seem largely peripheral to ASX-SGX, they have been raised in public debate.

2 Based on SGXs last traded price of S$9.54 prior to announcement of the proposal and the prevailing exchange rate at announcement of S$1 = A$0.787.



The questions of national interest most relevant to this proposal are economic in nature. The core question is whether Australias economic prosperity is promoted or adversely affected by ASX-SGX.

The national interest test under FATA is that the Treasurer is empowered to block ASX-SGX if it is found to be contrary to the national interest. On the other hand, the CA test in relation to the acquisition of more than 15% of voting power in the futures market licensee, and clearing and settlement facilities licensees and their holding companies, is an affirmative test: the Minister must find that the proposed acquisition of shares in ASX by SGX, giving rise to this downstream voting power in other licensees and their holding companies, is in the national interest before the Minister may approve the acquisition.

In each case, the Treasurer (who in this case is the Minister) may impose conditions on his approval. (There is no specified test for the Minister in determining whether to introduce the regulation to allow the acquisition by SGX and its subsidiaries of voting power of more than 15% in ASX Limited.)

1.3 Approach to the analysis

This report assesses the national interest implications of ASX-SGX under four headings (see Figure 1.1):

the implications for Australias standing as a regional financial services hub in Asia;

the impact on the cost of capital for Australian companies;

the impact on Australians ability to diversify their savings; and

the implications for regulatory control of exchange trading, and clearing and settlement facilities in Australia.

Figure 1.1: Assessing the national interest

The first three headings in red (from left to right) relate to the CA requirement that ASX-SGX be consistent with Australias national interest. Our view is that ASX-SGX should be considered consistent with the national interest if it can be shown to promote the economic prosperity of the people of Australia. The first three of our headings explore specific aspects of ASX-SGX which have the potential to improve the economic welfare of Australians.

Regional Financial Centre

Reduced Cost of Capital

Diversification of Savings

Regulatory Control

New Products & Services

Diversification of Earnings

Enhanced Distribution

Reduced Costs of Operating



A finding that ASX-SGX is not contrary to Australias national interest (the FATA test) requires the Treasurer to conclude that the economic prosperity of Australians would not be adversely affected by the proposal. Our fourth heading addresses this issue directly.

ASIC and the RBA are the two regulators responsible for supervising Australias exchange trading, and clearing and settlement facilities. They are both charged in broad terms with securing Australias economic prosperity.

Importantly, ASIC (2010) has recently released its analysis of changing conditions in equity markets in which it anticipates heightened competition in exchange markets. ASIC acknowledges the benefits for Australia of reduced operating costs flowing from increased competition in exchange markets while seeking to uphold the integrity and soundness of Australias financial system.

So long as the authority and effectiveness of Australias regulatory agencies are maintained at their current levels, ASX-SGX will not adversely affect Australias national interest. Our fourth heading therefore addresses the question of whether ASX-SGX might in some way adversely affect the regulatory control exercised by ASIC and the RBA.

A crucial aspect of our assessment is the counterfactual. Deciding whether ASX-SGX is in the national interest or not also entails forming a view about what might occur if ASX-SGX were not approved. Not only might the potential benefits of ASX-SGX fail to materialise in this event but regression from the status quo might also occur. Assessing the potential benefits or costs of ASX-SGX cannot assume that the status quo would simply continue if ASX-SGX were not to proceed.

Figure 1.1 also shows how key elements of the commercial case for ASX-SGX articulate with the national interest assessment. The commercial case for merging the two exchanges is built on four pillars:

enhancing the potential to introduce new products and services across the merged exchange groups;

a combined group which has a more diversified earnings base and access to broader capital and investor groups;

enhancing the distribution of existing products and services; and

costs savings in operating the two groups as one, deriving benefits from scale, common systems and a single corporate office.

This report does not address the commercial case for ASX-SGX except as it relates to the national interest assessment. Importantly, neither the FATA nor the CA requires the Treasurer to affirm that ASX-SGX is a sound commercial proposition in itself. This is a matter for the shareholders of ASX and SGX to determine.

1.4 Contents of this report

Chapters 2 to 4 present reasons why ASX-SGX should be considered consistent with Australias national interest:

Chapter 2 discusses Australias potential as a financial services hub in Asia;



Chapter 3 discusses Australias reliance on foreign capital and how ASX-SGX might improve access to and lower the cost of capital to Australian borrowers/investors; and

Chapter 4 discusses the potential benefits from further diversifying Australian savings.

Chapter 5 discusses the implications for regulatory control of exchange trading, and clearing and settlement facilities in Australia. If there is no impact on the authority and effectiveness of Australias regulatory agencies, ASX-SGX cannot be judged contrary to the national interest, since this would imply that Australias financial regulators are incapable of securing the national interest through their regulation of the Australian operations of ASX-SGX.

Chapter 6 presents a number of illustrative examples of how the combination of ASX and SGX might work. The examples identify areas of cooperative opportunity that would benefit a diverse range of stakeholder groups. They are not exhaustive and, in all areas, are subject to regulatory approvals in both Australia and Singapore.

Chapter 7 examines the counterfactual case. ASX-SGX is a commercial response to competitive pressures in the market for listings, exchange trading, and clearing and settlement services. If this response is disallowed by the Australian authorities, the competitive pressures do not disappear. Assessing the national interest implications of allowing ASX-SGX to proceed involves comparing this outcome to the alternative of not allowing ASX-SGX to proceed.

Chapter 8 summarises the report and offers conclusions.



2 Australia as a Regional Financial Services Hub

Policymakers have long sought ways of establishing Australia as a regional financial services hub. Further connectivity with financial markets in the Asia-Pacific would clearly advance this objective. ASX-SGX is one initiative that could be a catalyst for further connectivity, and advance Australias aim of becoming a meaningful part of a regional financial services hub.

2.1 Unrealised potential

Australia has many attractive qualities as a market for financial services, including a skilled and mobile workforce, political stability, and a sound legal and regulatory framework. Furthermore, Australian financial markets already exhibit several of the key attributes required of an attractive financial services hub, including:

good governance and regulation of property rights;

a deep and increasingly mature pool of superannuation savings with a well-developed funds management sector; and

an English-speaking workforce in a world where English dominates as the language of global finance.

Figure 2.1: Exports and imports of financial services

0%

10%

20%

30%

40%

50%

60%

United Kingdom Singapore Hong Kong Canada United States France AUSTRALIA Japan New Zealand

Financial services exports

Financial services imports

% financial servicesgross value added

Source: Johnson Report (2009)

Yet despite also having one of the worlds largest pools of funds under management, a strong banking system and world-class exchange infrastructure, Australias financial services qualities have failed to translate into significant cross-border activity. Australias low level of exports and imports of financial services demonstrates an overly domestic focus (see Figure 2.1). Our



ambitions to become a regional financial services hub require stronger connections beyond Australias shores, most especially into Asia.

The Johnson Report (2009), published by the Australian Financial Centre Forum, addresses the strengths and weaknesses of Australias bid to become a more prominent financial centre. The report makes various policy recommendations aimed at promoting Australias chances, and notes that a deepening regional engagement is an essential first step. Indeed, the report picked Singapore as the best place to start.

The report emphasises that further integration with Asia-Pacific financial markets would be in the national interest as it contributes to the concept of an Asia-Pacific Community, and can contribute to Australias broader national economic and security objectives in the region.3

Broadly speaking, a successful financial centre offers easy access to deep, liquid and diverse pools of capital. It also offers access to sophisticated infrastructure that facilitates hedging and risk transfer activity. A higher level of cross-border financial activity is one way to strengthen these characteristics. While Australias financial markets are well-developed, sizeable and sophisticated, the level of managed funds sourced from offshore is relatively low.

The Johnson Report (2009) notes that, for instance, the proportion of Australias funds under management (FUM) sourced from outside Australia is between 3.5% and 11%, compared with 31% for the UK, 64% for Hong Kong and 80% for Singapore. This relative paucity of funds sourced from offshore reflects the overly domestic focus of the Australian financial services sector.

The Asia-Pacific region is the obvious target for Australias efforts to boost imports and exports of financial services. The Johnson Report (2009) notes that:

many Asian countries have high national saving ratios and are looking for opportunities to invest overseas, whereas Australia has a low national saving ratio and plenty of scope for investment;

many countries in the Asia-Pacific are looking to develop their private capital markets and Australia can contribute by becoming more broadly engaged in the region; and

a number of the regions multilateral bodies, including the Association of South-East Asian Nations (ASEAN), ASEAN+3, the East Asia Summit and the Asia-Pacific Economic Cooperation (APEC), have the development of Asian financial markets as a policy objective.

While Australias geographic location in the Asia-Pacific region is a potential advantage, the Johnson Report (2009) notes that not being on the Asian continent diminishes our profile in Asian financial markets. Australian financial markets tend to suffer from low brand recognition offshore and geographic remoteness. Without some physical presence closer to the Asian mainland, Australia will compete with other Asian financial centres for market access, the most prominent of which are Singapore and Hong Kong.

The low brand recognition of Australian financial services outside Australia impedes our development as a financial centre. Geographic distance from the main financial centres in the UK, Europe and North America explains the difficulty of establishing offshore brand

3 Johnson Report (2009), p.112.



recognition in these traditional centres. In the Asia-Pacific region, however, the tyranny of distance is reduced somewhat by compatible time zones and shorter travel times. The potential prize is also larger as Asian saving ratios and rates of economic growth easily outstrip those in the developed world.

The Johnson Report (2009) also cites regulatory and policy barriers as factors limiting cross-border transactions and fund raising. Australian-based fund managers seeking to offer their products in the Asian region face constraints on market access, including regulations that restrict the sale of funds management products to retail customers.

John Brogden (2010) in his 18 November article entitled Funds Passport is Australian financial players key to Asia published in The Australian identifies the inefficiencies currently evident in cross-border regulations particularly in reference to the financial services sector which denies our investment products access to our own region [Asia] and vice versa. The key barrier to Australias financial services entering Asian markets is the relative inability of an Australian fund manager to obtain a financial services license in most Asian countries. To counter this significant competitive drawback, Brogden supports the introduction of the proposed Asian Region Funds Passport.

Raising Australias profile in Asian financial markets is an important step in developing our ambitions to become a regional financial services hub. Stronger links with Asia will promote Australian exports and imports of financial services to levels more consistent with our standing as a sophisticated financial services marketplace.

Chapter 6, Section 6.1, further highlights the benefits of ASX-SGX for the Australian funds management industry.

2.2 Significance of ASX-SGX

Australias latent comparative advantage in financial services and geographic proximity to a relatively untapped Asian market underpin our potential as a regional financial services hub. Raising the profile of Australias financial services sector in Asia is essential to closer engagement with the region. ASX-SGX offers the potential to serve as a catalyst for this closer engagement to occur.

Chart 2.1 lists Sydney as an established national financial services centre offering a full range of services but with moderate international connections. Singapore, on the other hand, is described as an aspiring regional hub offering a similar range of financial services to Sydney but with much stronger international connections. Strengthening links between the Australian and Singaporean financial services centres, as ASX-SGX would do, would immediately improve the international connectedness of Australias financial services sector and align us with a recognised emerging regional hub.

ASX-SGX will maintain separately administered exchanges in both Singapore and Australia and act as a conduit of activity between the two centres. Cross-listing, cross-membership and mutual offset arrangements between the two exchanges (see Section 6.2) will form the basis of the conduit. ASX listings will obtain immediate profile in Asia through cross-listing on the SGX and Asian investors will gain easier access to Australian stocks.



The scope for developing new products and services will improve with the combination of the two exchanges under the ownership of one group. Innovation in products and services is the hallmark of a financial services centre. The enhanced scope for developing cross-currency derivative products and expanded pan-Asia indices is an achievable short-term benefit of ASX-SGX (see Section 6.2). From Australias perspective, ASX will receive increased visibility within the global investment community, raising interest in and enhancing the relevance of Australian financial services more generally.

Chart 2.1: Overview of key financial centres

Source: Citi, Oliver Wyman in UK international financial services the future, 2009.

Furthermore, an enhanced profile for Australia within Asia and beyond will improve the chances of attracting financial services professionals to, in particular, Sydney, Melbourne and Perth. In other words, the proposal will enhance Australias financial centre employment credentials. Financial services are intensive in human capital, which, unlike fixed plant or mineral resources, can re-locate quickly.

Given the appeal of Australian cities such as Sydney, Melbourne and Perth as places to live and the importance of amenity and liveability to financial services professionals, being able to live and work in Australia while remaining connected into Asian and global financial markets is an appealing prospect. In this respect, far from exporting high-value jobs to Asia, ASX-SGX helps



to build links, which facilitate highly skilled professionals moving to Australia to build careers focussed on Asia.4

Brand recognition counts for a great deal in financial services. According to Deborah Ralston (2010), director of the Australian Centre for Financial Studies, ASX-SGX would demonstrate a genuine integration of Australian and Asian financial markets, and potentially reposition Australia. The merger would be a game changer in relation to Asian attitudes towards Australias commitment to the region.

Appearances count but nowhere more so than in Asia. For Australia to have any chance of becoming a regional financial services hub, we must first demonstrate commitment to the region and a genuine willingness to engage.

ASX-SGX aligns two of the regions strongest exchange groups to form the fifth largest exchange group in the world by market capitalisation. Such a transaction places the merged exchange group squarely on the international financial services map as a significant and relevant global player based in the Asia-Pacific region.

ASX-SGX will help Australia become a regional financial services hub by: (i) building a conduit into Asian financial markets to improve financial flows from Australia into Asia and vice versa; (ii) connecting Australias funds management industry to fast-growing pools of Asian savings; and (iii) raising the profile of Australian financial markets within Asia and beyond.

4 The ASX itself employs around 500 people. It is expected that only a few executive positions would transfer to Singapore as a result of combining ASX with SGX, while a number of new executive positions would be created in Australia. Other jobs are unlikely to be significantly affected by the formation of ASX-SGX.



3 Reduced Cost of Capital

Australias standard of living owes much to its ability to attract and effectively use foreign investment. Access to overseas capital has fostered higher rates of economic growth, developed new industries and infrastructure, and strengthened trade and investment links with the rest of the world. Indeed, a reliance on foreign capital has been a prominent long-term feature of Australias economic development given the limited size of our own capital markets and the dominance of capital-intensive industries, especially mining.

Australian workers use the nations stock of capital in order to create output (i.e. their own skills are married with physical infrastructure such as mines, factories, office blocks, roads, ports, and computers and other equipment).

In recent times, Australias labour productivity growth has become dependent on capital deepening that is, the stock of capital per worker.

The other source of productivity growth comes from innovation in its many guises (multi-factor productivity growth). The Grattan Institute has identified better access to risk finance as a likely key component in improving Australias innovation effort and lifting Australias productivity performance.5

Productivity growth as a result of either capital deepening or innovation improves the effectiveness of workers, boosting their incomes as well as the profits of the businesses which have invested.

Australias history of current account deficits and the likelihood that those will lift in order to finance the surge of resource and infrastructure projects being approved makes access to and the price of capital among the most important determinants of Australias national investment and national economic prosperity.

ASX-SGX has the capacity not only to ensure but to bolster Australias economic prosperity by:

increasing access to foreign capital; and

lowering the cost of capital as a result of increased scale, liquidity and diversification.

This chapter first explains in more detail why Australias economic prosperity is so reliant on foreign capital and then discusses how ASX-SGX is likely to improve access to and lower the cost of capital.

3.1 Reliance on foreign capital

While reliance on foreign capital has been a prominent long-term feature of Australias economic development, our dependence on foreign capital has increased largely because of a major boom in mining investment. Domestic savings are insufficient to finance investment on the scale required, especially when the need for additional infrastructure is taken into account. Hence, foreign capital will be required in substantial amounts to finance Australias national investment.

5 Grattan Institute (2010).



Foreign capital, especially in the form of foreign equity, should be encouraged because:

1. Australias current account deficit is high and rising.

2. Australia is over-exposed to short-term foreign borrowing, and equity capital has important advantages over debt capital.

3. Australia benefits from foreign direct investment (FDI) and Asia, an increasingly important source of FDI internationally, is under-represented as a source of FDI into Australia.

These points are considered in the following sections.

3.1.1 The vulnerability associated with our current account deficits

Australia has been investing more than it has been able to muster from domestic savings since it was colonised. National statistics collected since Federation show the dominance of current account deficits (Chart 3.1).

Chart 3.1: Australias current account deficit since Federation (% of GDP)

-6

-4

-2

0

2

1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s

Century average

Past three decades average

Source: ABS Cat. No. 5302.0, 5206.0, the Reserve Bank, Federal Treasury.

It is not unusual for young nations to run current account deficits, because the opportunities to invest often outstrip a developing nations ability to finance those opportunities. Somewhat surprisingly, investment opportunities in Australia have grown over time. Over the last three decades, Australias current account deficit lifted further as a share of the economy.

The lift in mining investment in recent years has already seen gross investment in Australia outstrip that of many of our peers. In addition, the increased investment required to pursue the increased opportunities now available to Australia, as a result of the current resources



boom, is likely to mean an even higher average current account deficit is in prospect. This will involve an even greater reliance on foreign funding, particularly wholesale funding.

More detailed discussion of risks associated with current account deficits is provided in Appendix B.

It is worth highlighting that any slowdown in the economies of China and India would create additional risks for Australia. A slowdown in China and India would likely reduce our export earnings more than it would reduce our import costs. These two effects would combine to raise an already elevated current account deficit.

In turn, a higher current account deficit could be associated with unwillingness by foreigners to lend to Australia during what could be a difficult period. Volatility affecting China and India is likely to shape foreigners perceptions of Australia because Australia is a major supplier to these two economies.

Australias reliance on foreign funding is likely to increase and be increasingly subject to events affecting China and India.

3.1.2 Exposure to short-term foreign borrowing

Around 40% of Australias foreign liabilities (comprising debt and equity) is accounted for by foreign borrowings by domestic banks. In 1990, the ratio was only 20%.

Australian banks share of foreign debt is higher than in previous times, as is their share of financing of the current account deficit. Consequently, the ability of Australian banks to borrow abroad is important for financing investment in Australia.

Australian banks borrowing abroad has a relatively short maturity it is impatient capital. The ABS reports that 44% of the foreign debt liabilities of Australian depository institutions have a maturity of less than 12 months (ABS Cat. 5302.0, Table 1). By contrast, direct equity stakes by foreigners in Australian firms is patient capital.

The Global Financial Crisis (GFC) raised awareness of and concern about the danger of financial sector instability in the face of external shocks and how impatient capital can seize up when it is most needed. At the peak of the GFC, Australian banks were forced to pay more than 200 basis points over the swap rate for wholesale funds. The breakdown of interbank markets forced the Australian Government to guarantee wholesale funding for Australian banks.

Official concerns about the risk to financial system stability from high and increasing levels of market concentration in Australian financial markets are likely to persist. As Dr Ken Henry has pointed out, during the crisis the major banks:

increased their market share of most financial products;

increased their net interest margins; and

increased their share of owner-occupied housing loan approvals (rising from around 60% ahead of the crisis to around 82% in early 2010).



Australias rising reliance on foreign funding is dominated by short-term banking debt and our domestic banks are the major source of debt capital for Australian corporates and individuals.

Australian banks reliance on short-term and offshore funding sources carries risks.

The recent GFC highlighted Australias vulnerability to a meltdown in global capital markets, when debt financing seized up almost overnight.

The rise of securitisation markets underwrote greater access by Australian lenders (and, indirectly, Australian families) to cheap financing during much of the past decade. These markets seized up during the GFC and are only recovering slowly.

Basel III will make bank-issued bills and bonds less attractive. The proposed Net Stable Funding Ratio is intended to promote longer-term structural funding of banks balance sheets, off-balance sheet exposures and capital markets activities. This means that Australian banks will need to find alternatives to short-term sources of funding. The higher capital requirements proposed under Basel III will also increase banks demands for equity capital, at least over time.

In contrast, Australias net reliance on foreign equity capital (at $92 billion in mid-2010) is one-seventh of our reliance on foreign debt (at $673 billion), whereas three decades ago these two components were of equal size (see Chart 3.2). There are important risks in our growing reliance on foreign debt. Patient direct equity involves a greater sharing of risks and rewards than debt financing, and it is less vulnerable to capital flight at times of turmoil. Hence, any shift towards direct equity financing over debt financing would reduce the potential volatility of future capital flows.

Chart 3.2: Australias net foreign liabilities (% of GDP)

0%

10%

20%

30%

40%

50%

60%

1980-81 1984-85 1988-89 1992-93 1996-97 2000-01 2004-05 2008-09

Net foreign equity Net foreign debt

Source: ABS 5302.0, 5206.0



It is therefore particularly important to Australias future prosperity that Australian companies have access to foreign-sourced equity at the best possible price.

The availability and pricing of equity capital is facilitated by securities exchanges. The greater the size, liquidity, and reach of an exchange:

the more cheaply it is able to assemble capital from investors; and

the better the exchange can match the risk and reward preferences of investors and companies.

Accordingly, the increased size, liquidity, reach and accessibility to a wide range of investors of ASX-SGXs markets will have important advantages in helping Australians achieve greater economic prosperity.

3.1.3 Benefits of foreign direct investment funds

Access to overseas capital over the past century has helped Australia foster higher rates of economic growth, develop new industries and infrastructure, and strengthen trade and economic linkages with the rest of the world. Ensuring Australia continues to be an attractive international investment location is of critical importance to our national interest and future prosperity.

In 2007, Australia received around 1.8% of global portfolio investment. It also received about 2.8% of world foreign direct investment in 2008, the ninth largest recipient of this form of investment. Both those shares are higher than Australias share of world GDP (1.7% in 2008).

The UK and the US are Australias largest sources of foreign investment, at around a quarter each of total foreign investment in this nation. Yet the longer-term growth of capital flows into Australia (which have already increased significantly over the last decade) are unlikely to come from the US and UK, particularly given the stress that both countries are under to correct their fiscal imbalances.

Rather, the growth opportunities of the future are likely to be those that connect the fast-growing capital pools of Asia with good underlying economic growth and world-leading saving rates with investment opportunities opening up in Australia.

ASX-SGX is a natural fit for encouraging Asian capital to invest in Australian potential.

Increases in foreign investment flows reflect greater global integration. As countries such as Australia have become more trade-intensive, cross-border investments have also grown. Notably, this is part of the broader tendency for firms to drive efficiencies by undertaking activities on a more global basis.

Australia is one of many locations that vie for a limited supply of foreign capital. In the wake of the global financial crisis, foreign capital is more limited and more costly. Nonetheless, Australia should aim to improve its attractiveness to foreign capital, especially from regions which appear to be under-exposed to the benefits Australia offers, because the economic pay-



off for us (and for them) will be greater. However, should active policy interventions or ill-judged pronouncements discourage overseas investors, the economic consequences are likely to be negative.

Chart 3.3: Australian exports versus stock of foreign direct investment

Source: ABS Cat. Nos. 5368.0, 5352.0.

The relationship between Australias export trade and foreign investment can be seen in Chart 3.3 above. Some broader structural differences are noticeable in the investment-to-export trade intensity of Australias more traditional providers of foreign capital and key Asian markets. The chart maps out a simple relationship Australian exports to a nation and investment in Australia from that nation tend to be linked. However, those linkages are stronger for our old trading partners than for newer partners.

Other things equal, it makes sense for Australia to welcome foreign investment from Asia, giving the latter a stake in Australia commensurate with the stake our export earnings have in the health of those economies. Again, ASX-SGX is a natural fit for a greater alignment of such trade and investment linkages.

The choice of Singapore as a partner makes particular sense because the investment links between Singapore and ASEAN investors and Australian opportunities are not growing as we might have expected.

As indicated in Table 3.1, overseas investors had invested nearly $2 trillion dollars in Australian assets (as at 2009) including debt and equity holdings in Australian firms.



Over the past decade, the slower-growing OECD economies have nearly doubled the dollar-value of their investments in the Australian economy.6

At the same time, the investment stake in Australia held by the faster growing ASEAN7 economies (including Singapore) has remained virtually stagnant (0.1% average annual growth over a decade).

Table 3.1: Foreign investment in Australia by country/region (stock, $ billions)

Trend growth

% pa

2001 2005 2009 2001 to 2009

Singapore 39.9 19.7 40.2 0.1%

ASEAN ex-Singapore 7.2 17.5 11.5 5.9%

OECD 600.1 853.8 1,361.5 10.8%

Total all countries 856.7 1,240.3 1,897.7 10.5%

Source: ABS cat 5352.0

We might have expected growth in ASEAN investment in Australia to outstrip that of the OECD economies because:

the ASEAN economies have been growing strongly over the past decade; and

there are benefits to ASEAN investors in diversifying their portfolios by lifting their investment in Australian firms.

In addition to the investment opportunities provided by the mining boom mentioned earlier, opportunities for Australian firms to connect up with future growth in Asian savings will accelerate since the IMF forecasts that Asian net savings will double between 2010 and 2015.8

3.2 Significance of ASX-SGX

Australian companies such as Toll Holdings, Leighton Holdings, BHP Billiton, ANZ and Macquarie Bank that already have a physical presence in Asia will find it easier to raise capital in the region by listing on ASX-SGX via the proposed passport arrangements.

Given the reliance of Australias economic prosperity on continuing access to foreign capital, any proposal that increases access to and reduces the cost of foreign capital must be in the national interest. The following sections illustrate the potential impacts of ASX-SGX on foreign capital. This includes how ASX-SGX can increase liquidity and how increased scale, liquidity and diversification can lead to a reduced cost of capital. The impact of ASX-SGX on the cost of capital is also discussed in Section 4.2 below.

6 These estimates refer to stock estimates as at 30 June of each year. They do not refer to investment flows.

7 ASEAN member countries are Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. ASEAN members do not overlap with OECD members.

8 That is, savings less investment. The IMF projects Asian net saving will rise from 0.7% of OECD economic activity in 2010 to 1.5% in 2015.



3.2.1 Increased liquidity

As illustrated in Chapter 4, the combined group provides Australian companies with more access to foreign capital than the ASX alone.

Australian companies would benefit from gaining access to a larger investor base in Singapore (and Asia more broadly).

Australian market participants and intermediaries would benefit from a broader customer base, new products and services, improved post-trade margining and settlement efficiencies, as well as extended trading hours.

Australian investors would benefit from a greater range of stocks as well as new products and lower trading costs.

Trading costs are likely to fall due to technology efficiencies and deeper liquidity.

In addition to access to the Singapore market, ASX-SGX will also increase visibility of the merged group among the global investment community.

ASX-SGX would be Asias first exchange which straddles international boundaries. While such arrangements have become commonplace in Europe and the USA, ASX-SGX will be at the forefront in creating an international exchange group in the Asia-Pacific.

ASX-SGX will have a greater ability to attract international listings, which has the potential to further increase liquidity.

SGX already has off-shore hubs in New York, London, Chicago, Tokyo and Hong Kong, which provide global connectivity and an opportunity to grow international foreign exchange flows through Singapore.

Given that issuers and market participants will gravitate over time to the exchange with the most capital and the most cost-effective and speedy settlement and registration, Australia needs to be on the right side of those trends. The greater the size, liquidity, and reach of an exchange, the more cheaply it can assemble capital from investors, and the better it can match the risk and reward preferences of investors and companies. The evidence suggests that large global investment and hedge funds want access to deep, liquid markets.

Deborah Ralston (2010) claims that ASX-SGX is projected to generate a significant lift in profitability, increased liquidity, and opportunities in the market. The proposal is also likely to increase employment opportunities through a deeper and more complex capital market.

Although empirical analysis of securities exchange mergers is still in its infancy, one study substantiates the argument that a merger increases liquidity:

Padilla and Pagano (2005) analysed the effects of harmonisation of clearing systems in the Euronext exchanges and found that liquidity among the largest 100 stocks rose substantially.

The combination of ASX and SGX will bring more large firms from ASX to SGX than vice versa and more firms with foreign sales from SGX to ASX. ASX-SGX can therefore be expected to benefit from enhanced liquidity from both sources if the Euronext experience is a reliable guide.



3.2.2 Reduced cost of capital

A recent study by Nielsson (2009), which investigated the impact on market liquidity of the formation of Euronext, noted that the main motivation for studying liquidity is that it ultimately affects the cost of capital.

ASX-SGX will improve the connection between Australian investment opportunities and foreign investors, especially Asian investors with rapidly rising savings.

The improved connection will manifest itself in higher foreign levels of patient capital ownership of Australian firms.

This quantitative adjustment will be accompanied by a price adjustment namely, a cost of capital that is lower than otherwise. (The quantitative adjustment and the price adjustment are corollaries of one another, i.e., one would not occur without the other.)

The improved connection will enable Australian business-owners to more easily access capital on terms that are more attractive than otherwise.

As the cost of capital decreases, businesses are more likely to invest in new mines, factories, office blocks, roads, computers and other equipment. That boosts the productivity of Australian workers, and hence the income that they (and the nation as a whole) will earn in the future. Even a small change in the cost of capital can have a big impact on business investment over time, which is why the cost of equity finance raising money through securities exchanges is important.

IMPACT OF REDUCED COST OF CAPITAL

A reduction in Australias risk premium relative to other countries increases foreign investment inflows into Australia (as shown in BCA (2010)). This increase in foreign capital inflow has significant impacts. Most directly, an increase in foreign investment inflow adds to a countrys capital stock, increasing its productive capability and therefore output as measured by GDP.

In addition, there are two key flowon effects relating to employment. First, an increase in foreign investment adds to domestic demand, through greater activity in the construction sector. The construction sector is a major employer, and hence increased demand for construction services has secondround impacts through the economy in terms of increased employment and consumption.

Second, capital is a factor of production that combines with labour in the production process. Any increase in foreign investment inflow adds to the stock of capital and will also increase the demand for labour, increasing both employment and real wages. For instance, a 10% increase in foreign investment leads to higher real GDP of around 1.04% and increased employment of 0.32% at 2020. This equates to an increase in GDP at 2020 of around $14.3 billion in real terms and an employment impact of 34,400 full-time jobs.



New sources of capital may well shake up existing competitive arrangements, including the major role played by Australian banks.

Lower capital costs and access to more capital may be particularly important for smaller companies, which have fewer options to attract foreign capital than large companies do.

The SGX has a greater representation of small and mid-cap firms relative to the ASX. Two potential reasons are that (i) Asian investors are more comfortable gaining exposure to smaller firms and (ii) it is easier for smaller companies to list on the SGX.

ASX-SGX may well open up a channel of financing and investor interest in smaller Australian firms which have evidently been less successful in attracting the interest of Australian investors.

Reduced cost of capital as a result of increased scale and diversification

There are two ways in which the increased scale of the combined group can reduce the cost of capital:

through reduced risk (in the sense that the cost of capital is a function of reduced sovereign risk and the rate of return on the market portfolio); and

through reduced transaction costs.

Whether ASX-SGX actually reduces the cost of capital through reduced risk depends on Australias and Singapores sovereign risk rating and the diversification effect. Given that both Australia and Singapore have a AAA sovereign risk rating9, sovereign risk is unlikely to be affected by ASX-SGX; so cost savings are unlikely to stem from that part of the cost equation.

However, a larger and more diversified number of stocks traded by ASX-SGX may have an impact on the rate of return on the market portfolio and the combined equity risk premium assuming there is segmentation between the markets and clientele effects exist in each national market. As discussed in Chapter 4, ASX and SGX complement each other in relation to their industry composition and instrument offerings. This diversification has the potential to reduce the equity risk premium and thus the cost of capital (see Section 4.2).

The greater the size, liquidity, and reach of a securities exchange, the more cheaply it is able to assemble capital from investors, and the better the exchange can match the risk and reward preferences of investors and companies.

The largest component of transaction costs for market participants and investors is the bid-ask spread. As liquidity increases this spread typically decreases. Consequently, the increased liquidity resulting from the proposed merger will reduce transaction costs. Transaction costs may be further reduced through improved technology, as the combined, larger entity will be better placed to maintain investment in new, more efficient technology. This investment will be spread over a larger business, more market participants and greater trading volumes, further reducing average costs for market participants.

Section 6.4 further highlights how ASX-SGX improves efficiency for the market and its participants.

9 www.standardandpoors.com

http://www.standardandpoors.com/



The cost of equity capital is built up from the risk-free rate of return plus the equity risk premium and the bid-ask spread. The combination of ASX and SGX is unlikely to affect the combined risk-free rate of return but is very likely to lower the equity risk premium through diversification across formerly segmented markets, and lower the bid-ask spread through economies of scale in transactions.



4 Opportunities for Diversification

ASX and SGX are different enough yet sufficiently similar to offer scope for diversification across regions, markets and sectors to Australian savers and investors.

This chapter summarises relevant characteristics of ASX and SGX and identifies ways in which ASX-SGX will create opportunities for Australian savers to diversify their asset holdings more easily across Asian investments; and for Australian issuers of capital to broaden their sources of capital to include the rapidly growing pool of Asian savings.

4.1 Comparing ASX and SGX

4.1.1 History

The Australian Stock Exchange was formed in 1987 from the merger of six former State-based stock exchanges. In 2006 the then Australian Stock Exchange Limited merged with SFE Corporation Limited (holding company for the Sydney Futures Exchange), was re-branded as the Australian Securities Exchange, and the listed company renamed as ASX Limited.

On 1 August 2010 responsibility for the supervision of domestic licensed financial markets and for participants on those markets (including the relationship between participants and their clients) was transferred from ASX to ASIC. The Australian Government announced the changes to the supervision of Australias securities markets as the first step towards facilitating greater competition between market operators.

The Singapore Exchange Limited was established in 1999, following a merger of the Stock Exchange of Singapore with the Singapore International Monetary Exchange.

Both ASX and SGX are relatively young when compared with larger securities exchanges in the USA and Europe and are smaller on various dimensions, including market size, concentration and liquidity.

4.1.2 Equity markets

The Australian financial system has many positive attributes and is internationally regarded as safe and strong. SGX stands out as the nearest equivalent exchange in the Asia-Pacific region and the most compatible partner for ASX. ASX and SGX are not only compatible in terms of equity market profiles, but both exchanges also offer strong legal rights, and investor protection mechanisms.

Equity market size

Neither ASX nor SGX is ranked among the top 10 global exchanges by market capitalisation of the entities listed on their exchanges. On 30 December 2009 the listed market capitalisation of ASX was US$1,262 billion and SGX was US$481 billion. Had the two exchanges been combined at that date, the equity markets of ASX-SGX would have ranked eighth with a listed market capitalisation of US$1,743 billion, placing the combined group between Hong Kong Exchanges and TMX (which runs the Toronto Stock Exchange) (see Table 4.1).



Table 4.1: Major international exchanges

Exchange (location) 2009 market

capitalisation* (US$ billion)

2009 share turnover value

(US$ billion)

2009 listed companies (Number)

1 NYSE Euronext (US) 11,838 17,785 2,327

2 Tokyo Stock Exchange Group (Japan) 3,306 3,991 2,335

3 NASDAQ OMX (US) 3,239 28,951 2,852

4 NYSE Euronext (France) 2,869 1,982 1,160

5 London Stock Exchange (UK) 2,796 3,391 2,792

6 Shanghai Stock Exchange (China) 2,705 5,062 870

7 Hong Kong Exchanges (Hong Kong) 2,305 1,502 1,319

8 TMX Group (Canada) 1,677 1,240 3,700

9 BME Spanish Exchanges (Spain) 1,435 1,511 3,472

10 BM&FBOVESPA (Brazil) 1,337 626 386

ASX Group (Aust) 1,262 932 1,966

Singapore Exchange (Sing) 481 245 773 Source: World Federation of Exchanges (WFE) website. * Aggregate market capitalisation of companies listed on the relevant exchange at 30 December 2009.

Chart 4.1: Market concentration of the largest 5% of companies by market capitalisation

0

10

20

30

40

50

60

70

80

90

100

1996 2000 2004 2008 2009

Australia Singapore

% No. of companies in top 5% - 2009 Australia = 98 Singapore = 39

Source: WFE website.



Equity market concentration

ASX is one of the most concentrated exchanges in the world, second only to the UKs London Stock Exchange in terms of the proportion of aggregate market capitalisation residing in a small number of listed companies.

Chart 4.1 shows that in 2008 the largest 5% of companies by market capitalisation accounted for 85% of the aggregate capitalisation of all companies listed on the exchange. In 2009 the proportion had fallen only slightly to 80%. The largest six companies in Australia alone comprise around 35% of total market value.

SGX, by comparison, is a far less concentrated exchange. In 2009 the largest 5% of companies traded on SGX (39 companies) accounted for only 45% of the market capitalisation of all companies traded on the exchange.

When compared by size segment, ASX and SGX have similar profiles, as shown in Chart 4.2 and Chart 4.3.

Chart 4.2: Domestic market capitalisation by size segment

0

10

20

30

40

50

60

70

80

90

Large cap Mid cap Small cap Micro capAustralia Singapore

%

Source: WFE (2010).

Capitalisation classifications used by the WFE: large cap > $US 1.3 billion,; $US 1.3 billion mid cap > $US 200 million; $US 200 million small cap $US 65 million; and micro cap < $US65 million (2009 definition).



Chart 4.3: Number of domestic companies by size segment

Australia

Large cap Mid cap Small cap Micro cap

Singapore

Large cap Mid cap Small cap Micro cap

Source: WFE (2010).

Capitalisation classifications used by the WFE: large cap > $US 1.3 billion,; $US 1.3 billion mid cap > $US 200 million; $US 200 million small cap $US 65 million; and micro cap < $US65 million (2009 definition).

Market liquidity

Trading activity on SGX is small by comparison with exchanges elsewhere in the world. This is despite a relatively high level of offshore participation, as shown in Table 4.2. In 2009 SGX accounted for just 0.3% of global equities trade while ASX accounted for 1.15%.

Both are quite small compared with NASDAQ OMX, which accounts for 35.82% (including its European exchanges) of global equities trade. Had they been combined in 2009, ASX-SGX would have ranked close to rival exchange, Hong Kong Exchanges, with a combined share of 1.45% of global equities trade (see Table 4.2).

Table 4.2: Value of share trading of selected stock exchanges, 2009

Value of trade on main board Foreign trade

US$m % of world trade % of total market trade

NASDAQ 28,951,949 35.82 8.98

NYSE 17,784,586 22.00 10.83

Shanghai 5,061,643 6.26 0

Tokyo 3,990,909 4.94 0.03

London 3,391,103 4.20 30.91

Deutsche Brse 2,186,433 2.71 18.23

Hong Kong 1,501,638 1.86 0.18

Australia 931,555 1.15 4.54

Singapore 245,425 0.30 n/a10

10

This information was not available in the original data source.



Value of trade on main board Foreign trade

US$m % of world trade % of total market trade

Thailand 126,097 0.16 0

Indonesia 94,351 0.12 0

Malaysia 86,033 0.11 1.64

New Zealand 14,901 0.02 22.81

India n/a n/a n/a

WFE Total 80,827,344 Source: WFE website.

Sectoral representation

ASX is dominated by financial stocks (especially banks) and materials (mainly listed mining companies) (see Chart 4.4 Panel a).

SGX, on the other hand, has a broad sectoral spread with significant representation from manufacturing, services, transport and communications and property-related stocks, although financial stocks are also a significant presence (see Chart 4.4 Panel b).

Chart 4.4: ASX and SGX sectoral representation (proportion of market capitalisation)

Australia Panel a

0

5

10

15

20

25

30

35%

Singapore Panel b

0

5

10

15

20

25%

Source: ASX website and http://www.australian-economy.com/index.html; SGX website.

4.1.3 Debt markets

Table 4.3 shows the worlds top 10 exchanges by total value of on-exchange bond trading. Neither ASX nor SGX ranks among the top 10, with SGX ranked 22nd and Australia ranked 32nd. Nevertheless, bond trading is far more established on SGX than ASX, with the value of bond trading on SGX more than 15 times that on ASX in 2009 (see Table 4.3).

http://www.australian-economy.com/index.html



Table 4.3: Total value of listed bond trading 2009 ($US million)

Exchange Total value of bond trading Percentage of world trade

BME Spanish Exchanges 8,180,998 36.25

London SE 6,943,

20101206 ASX SGX AccessReport

Documents

Transcript of 20101206 ASX SGX AccessReport