Why ASX needs to lose control of listing rules

By continuing to have responsibility for listing rules, the ASX's dual role as a money-making enterprise and compliance supervisor remains fraught with conflicts of interest.

This was nowhere more evident than the proposals paper released this month, Strengthening Australia's equity capital markets. The paper recommends a profound change to its listing rules to enable companies with a market capitalisation of $300 million or less to issue up to 25 per cent of new shares each year on a non-pro-rata basis without shareholder approval, subject to two caveats.

The ASX's pitch was that Australia has a strong resources base but many are small capitalisation stocks and "have a narrow range of shareholders, which limits the usefulness of rights issues as a fund-raising tool". It argues that placements are therefore a crucial source of capital.

"Analysis of capital raisings in 2011 showed that placements provided close to 70 per cent of the secondary capital needs for mid to small caps," the paper argues. In a nutshell, it argues that Australia needs to do this to become more internationally competitive in the mining sector.

It sounds innocuous enough but non-pro-rata placements are anything but innocuous for the shareholders who are excluded from the placement.

Placements were hotly debated during the global financial crisis when a plethora of companies raised a combined $100 billion in fresh equity largely to reduce debt. More than $45 billion of those raisings were made via placements to selected institutional and sophisticated investors, meaning most retail investors missed out.

They were offered at an average discount of 12.3 per cent on the prevailing share price and the average dilution to shareholders was 19 per cent. What was even more concerning was existing shareholders paid for the privilege. A study released in 2010 estimates that investors paid just under 2 per cent of all capital raised - about $1.89 billion - to investment banks and other advisers.

Under the existing listing rules, listed companies can issue up to 15 per cent of new shares every year without shareholder approval. This allows companies to issue 15 per cent more shares on issue through a placement to a select number of investors at a massive discount.

The ASX's present proposal to lift this to 25 per cent on small cap stocks is open for consultation until May 14. Between now and then, the debate is likely to heat up as the Australian Shareholders Association and some large super funds come out in force questioning the basis of the proposal and why the ASX is willing to trade away share owners' rights when there is a lack of empirical evidence of how the present capital raising regime has made it harder or more costly for small cap companies to raise capital.

The proposals paper provides a list of contacts for further inquiries, including the general manager of capital markets. Listing commercial operatives rather than someone from the corporate governance council shows that this is purely a commercial proposal. Yet it is a proposal that could have negative implications for market integrity.

The ASX is a listed entity and as such its prime motivation is to make money for its shareholders. With competition from Chi-X and threats that clearing and settlement might be opened up, the ASX, under its new boss, Elmer Funke Kupper, is trying to find ways to bolster revenue. If that means finding ways to encourage more small start-up companies to list on the ASX to raise capital, so be it.

But while it continues to have responsibility for its listing rules, both perceived and real conflicts of interest will remain. In this case there is a strong argument that its commercial motives have come at the price of promoting good corporate governance in the market.

Put simply, a proposal to increase the limit to 25 per cent on small cap stocks would make it easier for changes of control to occur without shareholder approval. Under the Corporations Act, 20 per cent is the magic number for the control threshold. It means an investor cannot increase their stake from zero to 19.9 per cent without on-market purchases, an entitlement offer or shareholder approval in less than 13 months. Changing the placement limit to 25 per cent without shareholder approval would allow this to happen in one day.

Other ASX initiatives include a 12-month trial of an equity research scheme whereby the ASX will provide $1 million to fund the production of independent research for companies with a market capitalisation below $1 billion (about 1800, or 92 per cent of all listed companies). If successful the scheme would cost about $10 million a year. The recipients would be a mix of retail brokers and institutional brokers - their voting members.

A cynic could be forgiven for thinking the proposal to lift the cap on placements is nothing more than the ASX trying to drum up more business in the small cap sector after a proposal to create a second board was knocked back last year.

While the present proposal is aimed at companies with a market cap of $300 million or less, if it gets in, the ASX could use it to do what it has tried before: increase the placement capacity to all companies or use it to provide a waiver to companies close to the small cap threshold.