Room To Move On Conflict Management

Sydney Morning Herald

Friday August 15, 2008

Elizabeth Knight

While the media is perfectly within its rights to focus attention on the supervisory role of the Australian Stock Exchange over brokers and listed companies, and the management of the inherent conflict of interest this creates, the investors are far less concerned with the fox being in charge of the hen-house than the company's overall prosperity.

Yesterday the ASX released its full 2008 profit numbers and the body that supervises the exchange, the Australian Securities and Investments Commission, delivered its report card on how well it was managing conflicts and whether it was adequately bankrolling the supervisory function.

As I form part of the media contingent I'll start with the issue of the scorecard on supervision. Given the ASIC market assessment report didn't contain any kind of legend to navigate ASX's success - that is, A for excellent, B for very good, C for adequate, D for could do better - it's hard to get a feel for how it's doing.

The overall conclusion concerning just about all the functions the ASX takes under its legal obligations is that it fulfils them "adequately".

Having said that, there were 10 points ASIC highlighted where the ASX needed to do more - particularly in view of the difficult environment in which it now operates.

Without going into all of them in detail, they centre on keeping some distance between its commercial role as a securities exchange and its function as a regulator and to clarify these distinct roles.

The other theme highlighted was how the supervision was funded and its allocation of human resources. ASIC wants additional certification of supervisory expenditure.

In response to the failure of the broking firm Tricom to settle on time a few months back, one of the 10 points was that ASX should revise certain settlement processes.

None of the points is devastating but they will certainly provide some fodder for those that argue a regulator cannot operate most effectively with a commercial conflict of interest.

The ASX is deeply sensitive on this issue, arguing fiercely that it is in its commercial interests to have a properly regulated market because a poorly regulated market would lose business.

But in the short term, regulation is a cost centre and the natural order of companies that are attempting to increase profit is to reduce cost.

Which brings us to the issue that will be focusing the minds of ASX shareholders - the potential for the company to increase profits in the current volatile environment.

For 2007-08 ASX managed a creditable increase in net profit of almost 17 per cent.

But in the first half - before the equity markets hit the wall - the company was tracking a profit rise of about 35 per cent over the previous corresponding period.

When the markets fell out of bed so did the ASX's ability to make super profits. In the second half of 2007-08 the company made 4.5 per cent less than it did in the first half.

In some respects it was saved during this volatile market by a very high volume in equities trading. But the slump in share prices more than offset this increase in volume.

The trading in the first few weeks of this financial period, 2008-09, has also been strong in terms of volume but share prices remain volatile.

And many of the one-off gains flowing from the ASX merger with the Sydney Futures Exchange two years ago are now complete.

The ASX boss, Robert Elstone, is in an impossible position attempting to predict short-term profit and was understandably reluctant to do so as he is hostage to a market he can't control.

Elstone is pinning his hopes on the ongoing measures to enhance platforms, products and services to bolster medium-term prospects.

With an increasingly sophisticated market and the opportunity to use this trading platform for new products such as carbon credits, there is every reason to believe that when the financial markets settle, the ASX will be well placed to grow.

But right now buying shares in the ASX is akin to buying a futures contract on the share price index - it's a lottery.