Box B: The role of capital markets in the New Zealand financial system
Capital markets are financial markets that facilitate the buying and selling of long-term debt and equity instruments. By channelling the wealth of savers to those that are seeking to raise long-term capital, these markets complement the intermediation role played by banks and other financial institutions.1 Well-developed capital markets also enhance the capacity of economic agents to manage and price risk.
In the New Zealand context, there has been a long-standing concern that financial system development, and broader economic welfare, has been inhibited by the relatively underdeveloped nature of New Zealand’s corporate bond and equity markets. In 2009, the Capital Markets Taskforce argued that New Zealand’s capital markets were failing as an ‘engine of growth’ for the economy, with too few companies growing large enough to compete on the world’s stage.2 Key deficiencies highlighted were an over-reliance on bank funding by SMEs, a stock exchange that is small by global standards, and a corporate debt market that offers a limited range of quality services.
The cross-country literature has found a positive relationship between the level of financial system development and long-run economic growth.3 Underdeveloped banking and capital markets can hamper economic growth by preventing the financial system from effectively performing its vital functions, such as allocating resources across time and space, and managing and pricing risk. In the New Zealand context, further capital market development may enhance financial system efficiency by increasing the avenues for financing and broader risk mitigation by New Zealand firms.
In terms of total market capitalisation, the New Zealand stock market is small by international standards (figure B1). In addition to differences in production and ownership structures, the relatively small size of the equity market partly reflects the size of New Zealand firms, with the turnover of most firms being too low to justify listing on the stock market, due to prohibitive issuance costs and high compliance standards. To partly address this issue, the NZX has proposed a new ‘stepping stone’ market – called ‘NXT’ – offering cheaper access to funding and lower compliance costs for SMEs worth between $10 million and $100 million. The NXT was approved by the Financial Markets Authority (FMA) in September, and is expected to launch later this year. With the new market, the NZX is hoping to attract high growth companies through features such as streamlined regulation and the presence of market-making and research to aid liquidity. To the extent that it succeeds in doing so, this should enhance financial system efficiency by broadening the sources of financing available to SMEs.
Figure B1: Stock market capitalisation – OECD (percent of GDP)
Source: World Bank, RBNZ.
The number of new domestic retail investors participating directly in the New Zealand stock market appears to be increasing over time, helping to enhance market liquidity and international interest. If this trend is sustained, more firms may be encouraged to publicly list as an alternative to bank funding or private equity. The growth in KiwiSaver funds may also support the development of the domestic equity market.
In July the FMA issued its first equity crowd funding licences under the Financial Markets Conduct Act 2013. Crowd funding is a new way for small firms to raise capital. A service provider acts as an intermediary between companies in the early stage of development, and investors. Firms issuing securities through crowd funding require less disclosure than companies listed on the registered exchange, NZX.
Crowd funding is one example of wide ranging regulatory reform over the past several years aimed at reducing capital-raising costs for both listed and unlisted firms. This regulatory reform is also intended to increase the overall level of investor confidence in New Zealand financial markets.
With respect to debt markets, the breadth and liquidity of the government bond market can influence corporate debt market development. A well-developed and liquid government yield curve, for example, can assist in the pricing of corporate securities, and therefore more accurately determine the cost of capital for firms. Historically, the lack of long-term New Zealand government bonds to act as benchmark securities may have limited the ability of corporates to issue long-term debt and contributed to the corporate bond market remaining small and illiquid.
Since 2008 there has been increased issuance in the New Zealand government bond market to fund fiscal deficits stemming from the recession and the rebuild of Canterbury (figure B2). Throughout this period, the New Zealand Government has faced relatively low borrowing costs (by historical standards), while a lack of national savings and strong international demand led to a rise in the proportion of non-residents holding New Zealand government debt. The development of the Local Government Funding Authority, which helps local authorities throughout New Zealand raise funds for capital expenditure more efficiently, has also encouraged a significant increase in local government debt issuance since 2012.
Figure B2: Government securities outstanding
Note: SRESL refers to the Southern Response Earthquake Services Limited.
The long-term debt of New Zealand banks, when issued domestically, can also help facilitate capital market deepening. In recent years, the issuance of bonds by New Zealand banks has been reasonably subdued, reflecting the role of domestic retail deposits in largely meeting bank funding requirements (see chapter 5). Issuance has picked up somewhat over 2014, as banks have rolled over their debt to maintain their presence in the market.
In terms of New Zealand non-financial corporates, widening bank funding spreads and tighter bank lending conditions during the crisis precipitated an increase in activity in the local corporate bond market, as large (and highly-rated) firms sought to obtain cheaper, more diversified sources of funding (figure B3). Issuance subsequently declined, partly due to increased competition for corporate lending from the banking system.4 More recently, corporate bond issuance has picked up, both domestically and for New Zealand firms issuing in offshore markets, reflecting favourable funding conditions and investor willingness to hold NZD assets. Over time, continued growth in corporate bond issuance should help to build market liquidity and broaden the investor base for corporate debt in New Zealand. However, the limited number of New Zealand non-financial corporates in rating categories which meet the majority of institutional investor mandates (typically single-A and above) may impede new issuance over the longer term.
Figure B3: Non-financial corporate bond domestic issuance (annual totals)
1 Debt and equity securities can be issued on both public and private markets. The NZX is an example of a public market where new stock is issued and sold to investors (who become shareholders). Public markets also involve the trading of existing securities on ‘secondary markets’. Private markets involve the non-public offering of debt and equity, typically to a small number of investors. Large firms may privately place large debt issues, while firms in the early stages of development might raise funds through private equity, and venture and angel capital markets. This box largely focuses on developments in New Zealand’s public markets.
2 CMD Taskforce (2009) Capital markets matter: report of the Capital Markets Taskforce, December.
3 See, for example, Demirguc-Kunt, A and R Levine (2008) ‘Finance, financial sector policies and long-run growth’, World Bank Policy Research Working Paper 4469, January. Note, economic growth can also influence financial market development – in this sense causation can run both ways between deep and liquid capital markets and long-run economic growth.
4Domestic non-financial corporate bonds outstanding is close to 5 percent of GDP, and bonds issued in offshore markets by New Zealand firms account for another 3 percent. By contrast, funding for the business and agricultural sectors provided by banks and non-bank lending institutions amounts to around 55 percent of GDP.