Modernisation of regulations and infrastructure to transform local markets in Papua New Guinea

 

After a number of challenging years, the Papua New Guinea’s capital markets seem to be finding their footing and may be on the cusp of great and positive change. In 2015 the country had its first initial public offering (IPO) in three years, and it was a significant listing: the company that sold the shares is a major local financial services group with part ownership of the stock exchange. Also, in 2016 a key stock started trading again after having been suspended in 2014.

Reforms Under Way

Significant reforms are being discussed, with Prime Minister Peter O’Neill weighing in, and these could result in the much-needed consolidation and modernisation of capital markets regulation and oversight. On the debt side, an electronic trading platform for bonds is being tested, reforms are being initiated (see analysis), and an international sovereign issue is still in the works and generating interest overseas. Most importantly, one of the key players in the subsector — the majority owner of the Port Moresby Stock Exchange (POMSoX) — has indicated a willingness to consider proposals for revitalising the market, including new investment and outside participation. “POMSoX welcomes anyone who wishes to participate in the stock exchange as a member or from an equity perspective,” Robin Fleming, CEO of Bank South Pacific (BSP), told OBG. “My guidance to them is to try to address any concerns about it being a closed network or a club between Kina and BSP and to put invitations to the market to other participants.”

At present the markets are far from optimal and have a long way to go. The stock exchange has only two brokers, two owners, fewer than 20 stocks and very little liquidity. Days can pass without a single trade being recorded. From the highs of 2010, the index is down about 50% and has remained there for a few years. Likewise, the bond market remains an over the counter (OTC), domestic, buy-and-hold proposition, with very little secondary trading at all and virtually no foreign participation (see analysis). But all indications are that the local markets are moving in the right direction and could be greatly transformed in the coming years. “The more you open it up, the better,” Fleming added. “At the moment, the activity in the market is counter-intuitive if you know that there is money in the system. There is very, very little trading.”

Market Basics

In some ways, the market’s very existence is a notable achievement. It is one of the only two exchanges in the Pacific region, the other being the South Pacific Stock Exchange based in Fiji, which began in 1979 as the Suva Stock Exchange. Trading on the exchange is fully electronic under the POMSoX Electronic Trading System, an order-driven platform imported from the Australian Securities Exchange (ASX), and brokers are able to conduct trades remotely from their offices via terminals. Settlement is T+3 (trade date plus three days), the current international standard. In addition, the market also has the right pieces and players in place and a sound legislation underpinning it. It has a share registry, PNG Registries, and a regulator, the Securities Commission of PNG (SCPNG), which is a division of the Investment Promotion Authority of PNG.

Based on similar laws in Australia and New Zealand, the Securities Act 1997 governs the stock market and the sector. It is a broad piece of legislation that established the SCPNG, sets out the requirements for stock exchanges and stock brokers, outlines the power of the regulators to prohibit trading in certain shares, defines the specifics for fidelity funds to handle claims against the exchanges, and prescribes the form and content of prospectuses. The act also discusses market manipulation, misleading statements, insider trading, substantial holdings and beneficial ownership.

The sector is also guided by the Securities Regulation 1999, under which more detail is provided about what information should be covered in a prospectus, how valuations should be reached in such a document and which investment statements must be included. The regulation covers unit trusts, their structure, management, governance and accounting, and has a section on substantial shareholder notices. A Takeovers Code was added in 1998. Prior to its enactment, mergers and acquisitions were more or less unregulated; they were covered minimally in the Companies Act 1973. The Securities Act 1997 called for the writing of a Takeovers Code, and one was created with reference to New Zealand takeovers legislation, which at the time was relatively advanced. The Companies Act 1997 is essential to the capital market and replaced the previous act, which was based on an English statute from 1948. It covers registration, transfer of shares, directors’ responsibilities, auditors and shareholder meetings, and was supplemented by the Companies Regulations (1998), which added considerably to the legal framework for liquidations.

The market has two indexes, the Kina Security Index (KSi) and Kina Securities Home Index (KSHi). They are both calculated by Kina Securities and are capitalisation weighted. The former includes all POMSoX listed shares, including those trading overseas, while the latter includes only companies that are listed domestically or those with most of their activities within the country.

Regulatory Changes

Some regulatory change has taken place in the past few years. The Takeovers Code was amended in 2013 to include a “national interest” test to the process, whereby the SCPNG can stop a transaction if it believes that it will harm the interests of shareholders or workers, reduce market liquidity, result in delisting or lead to the loss of local control. Additionally, the Companies Act was amended in 2015 with substantial revisions made to the existing regulations. As a result of the amendment, shareholders will have more rights, and directors will be held more accountable. In addition, companies can also buy and sell their own shares more easily, and they can now own Treasury stock. This was not allowed previously, and companies were required to cancel shares they purchased.

However, the market still has many deficiencies, which prevent it from becoming more liquid despite the many strong companies and the great amount of wealth available for investment. While the exchange itself is electronic and is able to process trades, the technology is outdated and the market infrastructure as a whole is underdeveloped. Clearing and settlement are still manual. The exchange is in need of a system update, and there is a need to upgrade the value chain for the market as a whole so that trades can be cleared and settled electronically and so that a system of custody can be established.

Challenges Ahead

The regulatory framework remains weak and does not provide the regulator with the tools or the authority to properly supervise the market. The SCPNG does not license stock brokers or unit trust managers, and its powers are highly limited. It has no control over the government bond market, has no power to supervise the brokers or the settlement system, and cannot license depositories or registries. The current registry is unlicensed and unregulated, although it does hold shares of all the listed companies. Brokers are licensed, but by the stock exchange, which acts on its own as a self-regulatory organisation.

The debt markets are similarly weak on the legislative side. They are underpinned by the Treasury Bills Act 1974, a four-page document that, in the most general and open-ended terms, allows for the issuing of Treasury securities, and the Loans Securities Act of 1960. The debt markets are also weak in other areas. Primary market sales are manual, inefficient and not particularly well managed, while secondary trading is rare, and when it does occur, it is handled OTC and manually settled.

The Takeovers Code has been of little use and is said to be ineffective. It is not very flexible and does not provide for a takeover panel to which queries or disputes could be referred. All relevant questions must be heard in court. Because of the uncertainty and potential for delay created by the lack of a dedicated venue, most merging parties have chosen to avoid the code altogether and combine via amalgamation or by a scheme of arrangement, both possible through the Companies Act. While the code was amended in 2013, the update was criticised for not bringing the law up to date. It dealt with issues of market protection rather than the with the mechanics of mergers and acquisitions, while its application was said to be vague and open to interpretation.

The lack of volume and price discovery at the stock exchange appears to be taking a toll on valuations, and strong companies are believed to be trading lower than they should. In this situation local companies seeking to go public are choosing to bypass the POMSoX and go straight overseas.

Moni Plus, a PNG non-bank financial institution, is planning to do a reverse takeover with a Singapore company, Jaya Holdings, by the end of 2016. As a result of the transaction, the PNG company will become Singapore-listed company and be valued at $232.2m. The sense is that liquidity and pricing will be better in that market than it would have been with a home country listing. Additionally, BSP is said to be contemplating a Singapore listing, but the company would not comment. “I looked at the home market, and comparable companies are not getting the valuations they deserve,” David Kelso, managing director of Moni Plus, told OBG.

Opening Up

The structure of the exchange is often blamed for the lack of development. It is owned by two companies – BSP Capital has 62.5% of POMSoX and the Kina Securities the remaining 37.5% – and this is seen leaving the exchange as less than competitive and lacking in investment and technology. While the two owners are well-run institutions and have every incentive to promote the exchange, as they, their customers and some of their investments are locally listed, it is generally believed, even by the shareholders, that it would be better to open up the market and encourage more investors.

The World Bank, according to a draft of findings from a recent technical assistance programme, has come out strongly in favour of reforming the stock exchange and bringing in more investors. In particular, international participation is recommended so that the exchange’s technology can be upgraded and key talent can be hired. “The POMSoX is limited with ownership vesting with only two licensed brokers, Kina Securities and BSP Capital. This does not necessarily offer a competitive or dynamic trading environment for government securities or equities on the exchange,” according to the World Bank technical assistance document, which was posted in 2015 by the Bank of PNG, the central bank. “It is strongly recommended that consideration be given to varying the stock exchange’s ownership from the current two shareholders by potentially allowing international ownership, which would import technology and knowledge to the local exchange.”

Bourse Performance

The stock exchange has always been a tentative institution. Discussions on the market began shortly after the country’s independence, but an entity was not formed for the development of the stock exchange until the 1980s. However, the country did not yet then have the capacity and knowledge to create an exchange. POMSoX finally became a reality in 1999. But despite one exceptional boom – when the market peaked in 2008 – the exchange has largely survived as an afterthought in the financial system. Marketing efforts by the exchange have been almost non-existent, with very little information provided about the listed companies and price performance, while research has been minimal.

Volume is very low, with most shares lacking any kind of trading at all on any given day. In mid-June 2016 POMSoX recorded no trades on any of the shares for three days straight. Price performance has also been poor. On June 17, 2016, the KSi index was at 4678.06, while the KSHi was 9579.23. The KSi has picked up a bit in recent months, having risen from 3417.51 at the end of 2015. However, prior to that, the index has been stagnant or in general decline. It was at 3496.88 at the end of 2014 while it reached a high of 7000 in 2010. The KSHi has not moved much in years. At the end of 2015 it was 9599.58, compared to 9555.27 at the end of 2014. It peaked at around 14,000 in 2008.

In 2015 a number of companies delisted from the exchange. In October 2015 Marengo Mining left the board, having been traded there since 2006. The company had earlier delisted from the ASX and said that it wanted to end its presence on the POMSoX to reduce its compliance costs. Meanwhile, in August 2015 Cue Energy Resources dropped its POMSoX Listing, and it is now only trading on the ASX (it had listed in PNG in 2000). It had delisted from the New Zealand stock exchange earlier. New Britain Palm Oil (which listed on POMSoX in 2001) delisted in April 2015 after it was acquired by Sime Darby. The latest company to leave POMSoX is New Guinea Energy, an Australian oil and gas exploration company, which delisted in June 2016 stating there had been minimal trading on the exchange since its listing in 2008 to justify further administrative costs.

Potential Interest

More than half of the listed shares are resource-related and more than half of the companies on the exchange have listings overseas, such as InterOil (New York Stock Exchange) and Newcrest (ASX). Companies providing key products and services locally are on the exchange as well, such as BSP, City Pharmacy and Steamships Trading Company, which was the first to list. Shares on the POMSoX have the potential to offer good exposure to the economy outside of resources.

While trading has been light, there has been some activity in recent months. BSP rose 6.7% in the year to mid-June 2016 after rising 5% in 2015. In 2014 the shares of the bank declined 10.5% and the year before that 1%. Meanwhile, Kina Asset Management was up 14.1% in the first half of 2016; it was down 15% in 2015 and 9.1% a year earlier, while it was up 22.2% in 2013. Oil Search rose 20.9% in the first half of the year, most of those gains coming after the proposed merger with InterOil. Credit Corporation was down 24.9% in the year to early June 2016 after having fallen 13.5% in 2015. Newcrest Mining was up more than 70% in the first half of the year and 8.3% in 2015. In Australian trading, Steamships Trading Company was down 17.9% in the first half of 2016.

While the market went without a new listing for three years, in 2015 a company came to market in a significant transaction. Kina Securities started trading on the POMSoX in July 2015. It sold 97m shares at PGK2.08 ($0.71) per share in a dual listing with shares also trading on the ASX. The stock has done well. By early June 2016 the shares were trading at PGK2.40 ($0.82). Kina Securities raised the capital in order to purchase Maybank’s presence in the country and to buy stock from one of the existing shareholders. The listing will also leave the company with working capital in order to expand and develop its banking business. The transaction was particularly significant as the Kina Group is part owner of the stock exchange and one of the only two brokers in the whole country. With its new banking licence, it is now a diversified financial conglomerate that has the resources and the retail customer base to develop the stock market.

One company returned to active trading. Listed in 2008, Airlines of PNG was suspended in 2014 as a result of a restructuring necessitated by poor performance and safety concerns. The carrier re-emerged in late 2015, rebranded as PNG Air and unveiled new aircraft. The airline’s shares dropped 54% in the first quarter of 2016 after no movements were reported in the previous year. But having the carrier back – and seemingly much improved – brings additional depth to the market.

High-Level Discussions

Since 2015 reform of the markets has been discussed seriously at the highest levels. More than just tweaking acts and improving market infrastructure, comprehensive changes have been mentioned. The prime minister has taken note of the lack of trading on the exchange, the less than ideal structure of market ownership and the weakness of the regulations, and three entirely new acts were proposed: the Securities Commission Act 2015, the Capital Market Act 2015 and the Central Depository Act 2015.

Since the acts were first mentioned, they have received very little discussion, but if they do resurface they are likely to dramatically change the way the sector operates. Under the proposed acts, the SCPNG will become an independent agency, and its capacity will be improved. A number of changes may also be made in terms of the licensing of intermediaries and other participants and in terms of disclosure requirements. Changes in the ownership structure of the stock exchange are a possibility, as are the development of more robust, international best-practice market infrastructure. In a separate but related development, discussions have been ongoing to consolidate all financial regulation under one roof, possibly the central bank.

Outlook

After years of low volumes, the PNG’s capital markets are poised for change. Reform has been seriously discussed, while the relevant institutions are on-board for improving the exchange and making it more efficient. Serious moves are also being discussed in the debt markets, including electronic trading. A wholesale restructuring of the sector seems in the offing. PNG has all the right pieces in place otherwise – the capital, the investment opportunities and a strong banking system to support more vibrant capital markets – so if it can get the structure and regulation right, more activity and better pricing are likely to follow in the future.

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The Report: Papua New Guinea 2016

Capital Markets chapter from The Report: Papua New Guinea 2016

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