Investing in an election year

Investing in an election year Markets in the political silly season

www.politicalmonitor.com.au

November 2012

Investing in an election year

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CONTENTS

About Political Monitor 3 Executive summary 5 Politics & markets 8

Political outlook | Nov 2012 – Nov 2014 11 Political risk & Australian equities

§ Resources 19 § Financials 25 § Telecommunications 28

Conclusion 30

Disclaimers, copyright & trademarks 31 Acknowledgements 32


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ABOUT POLITICAL MONITOR

Political Monitor is a political risk research and advisory

firm. Our analysis provides insight into the implications of

political risk for commercial valuations, asset selection,

investment decisions, strategic planning and operational

performance.

The firm was established to meet a need in the market for deep

strategic thinking about the business challenges and

opportunities that arise from political decisions. Our approach

inherently recognises that political risk, like any form of risk,

can produce both benefits and costs. Importantly, our work

goes beyond the day-to-day noise of politics and seeks to

identify longer-term political trends that confront markets and

firms.

What is political risk?

Political risk is the risk that derives from both the decisions of

government and the broader stability of a political system. It

has the ability to impact company valuations and influence long

term commercial planning. Political risk can emerge from any

level of government – local, state or national – and at any level

of decision making – political or bureaucratic.

While political risk is most often thought of in terms of country

risk the reality is that firms and investors can be exposed to

political risk at an industry, sector or firm level even in those

countries that represent as a safe risk at the macro level.


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Understanding Political Monitor’s risk ratings

In this report a number of specific political risks for industry are

identified and each is allocated a risk rating ranging from low to

severe. The rating is an opinion based judgement by Political

Monitor and reflects our perception of the likelihood of the risk

emerging and the potential impact on an industry or firm.

Political Monitor risk ratings

This rating signals a high level of stability in the short to medium term (12 months). Unexpected political decisions are considered unlikely This rating signals political attitudes towards an industry or firm are stable but changes to the macro environment (such as a change of government) may introduce heightened risk in the medium to long term This rating signals an increased level of uncertainty for an industry or firm and the risk of adverse political decisions and / or outcomes in the short to medium term have increased. This rating signals a significant level of risk for an industry or firm with adverse political decisions and / or outcomes highly likely.


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EXECUTIVE SUMMARY

The next twelve months present as a time of heightened

political risk for investors in the Australian market.

Ongoing leadership speculation, dramatic and unexpected

policy changes and a potential change of government at

the next federal election all contribute to an environment

of uncertainty. Perhaps of most concern is the emerging

reality of a political climate in which politics triumphs over

policy.

At the macro level Australia remains one of the safest and most

stable jurisdictions in which to invest and sovereign risk ratings

are right to present Australia in this light. However, beyond the

standard country level risk analysis investors are confronted

with a number of industry and sector specific risks that derive

directly from the decisions – immediate or potential - of

government.

However, not all of this risk is a result of events in the federal

sphere. State government budgetary constraints, a

forthcoming election in the resource rich state of Western

Australia and even global trade negotiations all contribute to

the political risk environment for investors over the next 12

months.

This report examines those risks with a particular focus on the

implications for key sectors in equities markets.

“Perhaps of most concern is the emerging reality of a political climate in which politics triumphs over policy.”


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Section 1 briefly discusses the link between politics and

markets. In Section 2 the general political outlook is examined

with a focus on two key areas - the broad implications arising

from either a change of government at the federal election next

year or the return of Labor; and the budgetary outlook for state

governments’ and implications for business.

Section 3 details the general impact on the resources

(including energy), financials and telecommunications sectors

of a raft of policy changes and reviews in addition to elections

federally and in Western Australia over the next 12 months.

In general, the report presents a picture of heightened

uncertainty for key sectors and identifies the political events

and trends that investors should monitor in order to manage

their portfolio exposure to political risk.

Key findings & risks:

• Investors face heightened political risk over the next

twelve months leading into the federal election –

uncertainty and the triumph of politics over policy will be the

dominant political trends confronting investors.

• Budget and election uncertainty – as a surplus gets

harder to achieve the chances of an early election increase.

The alternative is tax increases for business to fund

expected revenue shortfalls.

• State governments’ face revenue challenges – business

taxes may present as one solution.

“ … a picture of heightened uncertainty for key sectors ...”


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• Carbon tax and the politics of the Senate – over the next

12 months firms will need to make investment decisions

driven by the impact of the carbon tax but will do so

uncertain about its fate after the federal election.

• The energy sector becomes a political football – the

release of the federal government’s white paper signals the

start of a campaign to shift responsibility for power prices

away from the carbon tax and onto the states. Energy

companies will be the subject of intense political focus and

wrangling.

• Western Australian election and uranium mining – a win

by Labor would bring an end to new uranium mining

approvals. Conversely, new opportunities may emerge in

New South Wales.

• Government’s love banking inquiries – the banking

sector is likely to be subject to ongoing inquiries. The most

significant would be a Wallis style inquiry following a win by

the Coalition at the next federal election. In the meantime

there is a clear trend towards enhanced protection for

consumers of financial service products.

• Fibre to nowhere – the telecommunications sector will be

buffeted by the fortunes of the NBN under a Coalition

Government. Scrapping existing works and shifting to a

private sector model may not be as easy as planned.

However, providers of alternate technologies, such as

wireless, would benefit from a Coalition decision to move

away from fibre cables.


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POLITICS & MARKETS

Politics moves markets. One need only look at the

dramatic movement of global equities and bond markets in

recent years, as politicians have fumbled their way

through the global crisis, to understand this reality. Even

without a crisis political decision-making, or the lack

thereof, influences investment outcomes.

The political causes of these market movements are varied.

They include elections and the degree to which the outcome

was expected, changes in political leadership, dramatic shifts in

public policy and the underlying ideology of the political party in

office. Indeed in some markets a clear trend can be identified

simply from the normal course of the electoral cycle.

In the United States (US) the Presidential Election Cycle

Theory argues stocks decline in the year immediately following

a presidential election, then go up over the course of the next

three years, no matter who wins the election.

From 1937 onwards the Roosevelt, Truman and Eisenhower

Administrations all held to the theory with market declines in

their first year followed by a rebound over the next three years

of the term. However, more recently the elections of George H.

W. Bush and Bill Clinton brought market increases in the first

year.1 These recent experiences point to the need to consider

other theories.

“Even without a crisis political decision-making, or the lack thereof, influences investment outcomes.”


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One such alternate theory – from Ned Davis Research –

suggests that the analysis should consider the question from

the perspective of incumbent versus challenger rather than

political parties or stages in the electoral cycle. This analysis

leads to a clear trend in favour of incumbents regardless of

their political party of origin. On average markets have

performed best in presidential election years when the

incumbent has been returned to the White House. However,

investors should take note of the reliance on averages.

In Australia, recent research has suggested a correlation

between political party ideology and market outcomes.

Anderson, Malone and Marshall argue the electoral cycle

influences asset returns with property performing better under

Labor governments and stock prices more favourable to

Conservative governments. In the case of bonds capital losses

are discernible during Labor periods and capital gains are

apparent under Conservative governments.2

For investors the challenge is not just identifying the

emergence of political risk but being able to determine with a

degree of certainty the market impact of that risk, including any

ripple effects.

Adding to the challenge is that the relationship between politics

and markets is not always linear. Rather than political

decisions having an immediate and verifiable impact on market

performance it may be market events themselves shaping

political outcomes that in turn result in a new outlook for

investors.

“Adding to the challenge is that the relationship between politics and markets is not always linear.”


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Regardless of whether the relationship between politics and

markets is causal, or otherwise, the fact that a relationship

exists should be an important consideration in any investment

strategy.


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POLITICAL OUTLOOK | NOV 2012 – NOV 2014

Political risk: Heightened uncertainty until the

outcome of the federal election,

including make-up of Senate, is

known and the feasibility of key

Coalition proposals are tested

Prospect of an early election to avoid

revealing a federal budget deficit for

2013 prior to end of year poll

Threat of new and / or increased taxes

as federal and state governments’

struggle with budgetary constraints

The forthcoming federal election, which once offered the

prospect of a return to stability, is now emerging as a major risk

on the horizon for investors as the outcome becomes uncertain

and investors are unsure of the implications for key policy

areas of carbon pricing, energy reform, financial services

reform and the national broadband network. A Liberal –

National Coalition victory, still the more likely outcome, would

both remove the inherent instability arising from the recent

years of minority government and bring to power a stable

coalition of parties that have a long history of governing

together and are regarded as pro-business.

However, while markets will welcome this ‘stability dividend’ a

new government will in the short-term mean a number of policy

“However, while markets will welcome this ‘stability dividend’ a new government will in the short-term mean a number of policy changes and reviews that have the potential to disrupt current investment plans.”


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changes and reviews that have the potential to disrupt current

investment plans. This is particularly the case for financial

services, energy markets and telecommunications.

Conversely, the re-election of the Labor Government is unlikely

to bring stability to the Australian commercial environment.

Even with recent improvements in public opinion polls it is

highly unlikely that the Government could attain a majority in its

own right, meaning that once again its ability to govern would

be dependent on independent Members of Parliament in the

lower house and the Greens in the upper house.

In essence, the best-case scenario for Labor is a return to

minority government; an outcome that would see continued

political influence for those parties to the left of the political

spectrum and / or a number of protectionist independents.

Whoever wins the forthcoming election will assume

responsibility for a federal budget heading towards surplus.

However, there is considerable doubt emerging about the

timing of a return to surplus. This presents two clear risks to

business.

First, in order to deliver the promised surplus in 2013 the

Government will introduce new taxes, increase existing taxes

and / or remove business rebates to make up for the emerging

shortfall in tax receipts. The recent Mid Year Economic and

Fiscal Outlook highlighted this risk with the Government

prepared to make changes to company tax arrangements in an

attempt to maintain its target of a budget surplus in the current

year. Furthermore, the Government’s revised budget numbers

“However, there is considerable doubt emerging about the timing of a return to surplus.”


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are dependent on meeting its economic growth forecast of 3%,

an outlook supported by few private sector economists. If

growth falls below the Government forecast then more

spending cuts or revenue increases will be needed to make up

for the drop in national income.

Second, the Government may opt for an early election if it

believes a surplus is no longer achievable and wishes to avoid

revealing this prior to the expected end of year poll. The

Government’s political identity has become wedded to

delivering a surplus and a failure to do so will cut at the core of

its economic credibility. In light of weakening tax receipts the

odds of an early election are shortening, particularly if the

Government’s standing in opinion polls continues to improve.

Risks arising from budgetary constraints are also evident at the

state government level. Even those states endowed with an

abundance of natural resources, such as Queensland and

Western Australia, face budgetary challenges. The recent

decision by BHP Billiton to delay expansion of its Olympic Dam

copper and uranium mine in South Australia is a powerful

demonstration of the vagaries of commodity markets and the

pain that can be quickly inflicted on state governments

dependent on royalties as a revenue stream.

Australia’s geographic size means that each of the six states

are confronted with unique budgetary challenges as

summarised below:

“In light of weakening tax receipts the odds of an early election are shortening, particularly if the Government’s standing in opinion polls continues to improve.”


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New South Wales With a state budget deficit for the current fiscal year forecast to

exceed $800m and state net debt of circa $65bn the NSW

government must address both expenditure and revenue

challenges to return Australia’s largest state, and traditionally

the nation’s economic powerhouse, to a firmer financial footing.

While the state’s finances are expected to improve off the back

of public sector cuts and a program of privatisation new

pressures are likely to emerge if predicted softness in GST

revenues continue.

NSW does hold large reserves of coal; however, it lacks the

broader resource base of the outlying states of Queensland

and Western Australia. Furthermore, years of infrastructure

neglect means the state lags behind other coal producers, both

domestically and internationally, in its capacity to produce and

deliver coal at optimal levels.

In essence, the NSW economy is heavily dependent on

consumer spending and housing construction both of which are

subdued in the current climate. While the pro-business

Conservative Government is unlikely to directly tap business

for more cash through new taxes, levies and surcharges any

attempt to instead raise additional revenues from consumers

will ultimately impact business conditions, particularly those

sectors such as retail and construction that are so dependent

on consumer spending. Accordingly, the outlook is for a

general but subdued improvement in NSW government

finances as the Government seeks to improve its budgetary

position through expenditure cuts.

“ … the NSW economy is heavily dependent on consumer spending and housing construction both of which are subdued in the current climate.”


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Victoria At first glance the Victorian budgetary position is healthier than

that of NSW with projections of a $155m operating surplus for

the current fiscal year. Furthermore, business was enthusiastic

about the much-hyped cuts to Work Cover premiums.

However, unlike NSW the long range trend is not as positive.

Net debt is forecast to increase as a percentage of Gross State

Product (GSP) over the forward projections and revenues are

expected to decline as a result of drops in both GST and stamp

duty income. While business may welcome plans for critical

infrastructure investment, the fact that this is funded by debt

simply represents a future tax claim on business cash flows

and the deteriorating revenue position may mean those claims

need to be realised sooner rather than later.

Aware of its heavy dependence on manufacturing and

consumer spending for the state’s economic growth the

Government has elected to invest in blueprints for

manufacturing and exports. However, the reality is that those

plans will take years to develop and implement leaving the

state heavily reliant on the provision of professional services to

the mining and financial services industries, manufacturing

activity and consumer spending. Each of these areas is likely

to come under pressure over the next several years as the

mining boom continues to soften.

“However, unlike NSW the long range trend is not as positive.”


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Queensland In their first budget the Newman Government has decided to

take as much political pain up front as possible in order to

present a vastly improved state of affairs come the next

election. This has been achieved primarily through cuts to

spending and government employment and an increase in

taxes.

The focal point of the budget is the shift from a $10bn deficit

this year to a small operating surplus in 2013 – 14. Around

10,500 state government employees will be made redundant

and an additional 3,500 roles will be removed through natural

attrition. On the revenue side the Government is increasing

mining royalties for coal and increasing stamp duty on homes

sold for more than $1m.

Like the other states Queensland will struggle over coming

years with declining GST revenues and is seeking to make up

the shortfall through increased royalties. However, it confronts

two important risks with this approach. First, it may be

increasing mining royalties at a time when the boom is

softening and investors are less inclined to accept such

imposts. Second, the royalty gains, which essentially shift the

burden of the increase to the federal government due to its own

commitment to credit any such increases against its own new

mining tax, will likely be punished by the federal government

through additional cuts to GST or infrastructure grants.

In essence, Queensland is caught with too big a deficit at the

wrong end of a boom and its attempts to increase revenues

“In essence, Queensland is caught with too big a deficit at the wrong end of a boom and its attempts to increase revenues from the mining sector are likely to simply aggravate the industry’s emerging challenges.”


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from the mining sector are likely to simply aggravate the

industry’s emerging challenges. If the increased royalties don’t

provide the revenues needed the Government may be back

next year with more broad-based tax increases for business. Western Australia Western Australia is a clear example of a state experiencing

growing pains. The state is the economic powerhouse of the

nation with an abundance of resources in hot demand by

emerging economies, particularly China. Yet it faces large

infrastructure bills in order to ensure the state is capable of

meeting global demand and must fund this need from a

revenue base that is experiencing declining flows from the GST

and uncertainty about the federal government’s mining tax and

the resultant impact on royalties.

Fundamentally, the Government is struggling to raise the

revenues necessary to fund the state’s rapid expansion and it

runs the risk of investing too heavily at the end of a boom

potentially setting the state up for excess supply just as prices

start to soften.

The government expects a budget surplus of $196m but

government debt will increase from $15.6bn this year to

$23.156bn in financial year 2014 – 15. Much of the extra

expenditure is dedicated to infrastructure with $7.6bn allocated

to that purpose and $1bn set aside for a ‘Future Fund’. The

risk for firms operating in Western Australia is that the

Government will need to increase taxes to compensate for

declining GST revenues and income from the mining sector if

the boom has peaked. The rising expenditure on infrastructure

“Fundamentally, the Government is struggling to raise the revenues necessary to fund the state’s rapid expansion ...”


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increases the leverage and thus the risk for the Government in

a softening economic environment.

Western Australia has the greatest degree of uncertainty with

an election due in March 2013. While the Conservative

government remains popular in a traditionally conservative

state the Labor opposition needs only a small swing to return to

government. A Labor victory would bring a change of focus

and policy including to the taxation base.

South Australia South Australian finances are perhaps the most precarious of

all Australian states and the outlook for both fiscal improvement

and economic growth is not positive. As with all states South

Australia is confronted with declining GST revenues but rather

than use this reality as a trigger for expenditure cuts the

Government has elected to delay plans for a budget surplus for

at least one year and allow state debt to grow to 75% of

revenues by 2012.

With a declining population, a manufacturing base largely

dependent on government support and uncertainty around

major projects, as evidenced by BHP Billiton’s recent decision

regarding Olympic Dam, South Australia’s economic outlook is

weak and its fiscal position is unlikely to significantly improve in

the short to mid-term without a dramatic cut to public

expenditures and / or an increase in revenues.

“South Australian finances are perhaps the most precarious of all Australian states and the outlook for both fiscal improvement and economic growth is not positive.”


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POLITICAL RISK & AUSTRALIAN EQUITIES

Both the Australian All Ordinaries and the ASX200 – the

two most watched indices – are dominated by the

resources and financial services sectors. In the case of

the ASX200 BHP Billiton and the four major banks

(Commonwealth, Westpac, ANZ and National Australia

Bank) account for around 35% of the index. Unfortunately

for investors these two sectors are exposed to potentially

higher levels of political risk over the next 12 months.

Joining them is the telecommunications sector.

Readers should note that in addition to sectors identified above

the agricultural sector is exposed to significant political risk

arising from the outcome of the US Presidential and

Congressional elections and the implications for trade

agreements. The nature and implications of this risk are not

discussed in this report and instead will be the focus of a

forthcoming report examining the agricultural sector.

Resources – including Metals & Mining sector and Energy & Utilities sector

Issue: Carbon Tax

Political risk: Extended period of political

uncertainty

The primary political risk confronting the sector over the next

12 months centres on the carbon tax. The unexpected


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decision by the Gillard Government to abandon its proposed

floor price when the tax progresses to an emissions trading

scheme in 2015 (just a week after Minister Combet had flatly

rejected such an eventuality) was an important demonstration

that politics, rather than economics, is driving this issue and

highlighted the political risks associated with any investment

decision made in relation to the tax.

The greatest risk and uncertainty stems from the Opposition’s

pledge to repeal the tax if it wins power in 2013. While current

opinion polls point to a win for the Conservatives, investors

cannot simply precede on the basis that the tax will cease to

exist after the next election. Two challenges will make the

promise of repeal a hard one to keep.

The first challenge to repeal arises from the extent to which the

tax has become embedded in the Australian economy. It is

clearly the Gillard Government’s intent to make it impossible to

unscramble this egg and it remains unclear whether repealing

the legislation will be easier said than done.

The second challenge to repeal is the make up of the Senate.

Current polling suggests minor parties will again hold the

balance of power in the upper house and combined with a new

Labor Opposition they are likely to prevent the passage of the

necessary legislation to repeal the tax. While such a course of

action would be politically difficult for a new Labor Opposition,

which had just been rejected at the ballot box largely on the

back of the unpopular tax, carbon pricing has become such a

tenant of faith for Labor that repeal would cut to the core of

their identity in the modern era.

“The unexpected decision by the Gillard Government to abandon its proposed floor price when the tax progresses to an emissions trading scheme in 2015 … was an important demonstration that politics, rather than economics, is driving this issue …”


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These challenges reveal that the primary risk confronting

investors in planning around the carbon tax is uncertainty

derived from the political process. Consequently, the political

environment is likely to act as a drag on the sector until the

identity of a new government and the make up of the Senate

are clear.

Issue: Energy market reform

Political risk: Extended political uncertainty as the

federal and state governments battle

over a reform agenda and prices are

centre stage leading into an election

year

The federal government’s release of its energy white paper

(November 2012) maps out a clear path for reform of

Australia’s energy market. It includes price deregulation, price

signaling, the introduction of smart meters and hints at

privatisation of state assets. However, none of these

recommendations are groundbreaking and very little of it will

actually happen any time soon.

Energy prices have become a hot political issue as price rises

raise public consternation and political parties seek to shift the

blame to each other. This is the political context in which the

white paper’s recommendations will be assessed and debated,

accentuated by the prospect of an early election.

The Gillard Government, well aware of consumer perceptions

that the carbon tax is a key input into rising power prices, is


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keen to shift the burden for these increases to the state

governments. The energy whitepaper, through its focus on

state government reforms, provides a platform from which the

federal government can articulate its case.

This is not to say that the recommendations are wrong. But as

they are not new the Government hardly needed a whitepaper

to identify and develop a pathway forward. This leaves politics

as a primary driver of the white paper’s findings and timing.

The states – principally NSW and Queensland – will have none

of it. Both went to their last state elections opposing asset

sales and while the NSW Government is laying the groundwork

for reform it will not do so without an electoral mandate. The

Newman Government in Queensland is even more forthright in

its opposition to asset sales particularly of transmission assets,

which are essential to any wide reaching and comprehensive

program of energy reform. Queensland and NSW federal

counterparts, who want price hikes to be linked to the carbon

tax and not obscure debates about energy market reform, will

egg on these Conservative state governments in their

opposition to the federal government’s recommendations.

All of this places the energy sector at the centre of a heated

political debate only likely to get hotter as the nation heads into

an election year. The tantalising prospect of reform will in the

short-term give way to a political debate that provides little

direction for investors about Australia’s energy policy into the

future. Accordingly, the industry is confronted with an

immediate period of uncertainty, as it becomes a political

“This leaves politics as a primary driver of the white paper’s findings and timing.”


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football, and little guarantee that the post-election environment

will offer the prospect of wide sweeping reform.

Nonetheless, the white paper is correct in arguing that real

reform is dependent on the state governments. Price signalling

and smart metres in particular are essential to providing

consumers with both an understanding of the real cost of their

energy use and allowing them to control that cost.

Deregulation is at the core of this project. Asset sales are also

an important part of establishing market based pricing signals.

The proceeds from those sales also have the advantage of

being able to fund the development of other government

infrastructure projects.

Achieving these outcomes requires political will and the two

critical states in the reform process – NSW and Queensland –

are clear that electoral mandates are necessary for any such

reform. This destines the industry to be the subject of an

intensive political debate if reform is to become a reality.

Issue: Uranium mining

Political risk: Ban on future mining in Western

Australia if Labor wins forthcoming

election

Upside for industry following

Queensland decision to repeal ban

and NSW decision to allow

exploration


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While uranium mining has always been contentious in

Australia, which is the second largest producer after Canada,

public debate has been somewhat subdued over recent years

and the policy of respective governments, federal and state,

seemingly settled. That is beginning to change.

In Western Australia, where Premier Barnett overturned a

Labor ban on uranium mining in 2008, the prospects of the

Labor Opposition have been steadily improving since Mark

McGowan replaced Eric Ripper as leader in early 2012. While

a Labor victory has seemed unlikely for many years the reality

is that it failed to hold government at the last election by just

one seat and the introduction of one vote, one value during

Labor’s last period in office has decisively shifted political

power away from the regions and back to Perth, Labor’s

stronghold. This makes the prospect of Labor forming

government following the state election in March 2013 more

plausible than many have assumed.

The implications of a Labor win for investors with interests in

uranium related stocks would be decidedly mixed. McGowan

has clearly stated that his policy would allow existing mines to

continue operation along with those that had completed the

approval process prior to Labor taking office. But a Labor

Government would grant no new uranium mining licenses after

that point.

The outcome of this approach would see one set of firms,

those already mining or that have received approval, continue

to benefit from operations while those firms yet to complete the

approval process would be cut off from opportunities in

“This makes the prospect of Labor forming government following the state election in March 2013 more plausible than many have assumed.”


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Western Australia, which has some of the world’s largest

uranium reserves. Accordingly, investors exposed to uranium

mining in Western Australia need to be clear about which

category of investor they fall into – locked in or locked out.

Conversely, there is good news from Queensland and NSW.

In Queensland the Newman Government has overturned the

previous Labor Government’s ban on uranium mining and the

NSW Government has announced plans to allow uranium

exploration as part of a broader review into uranium mining in

that state.

The election of an Abbot led government may also hearten

investors in the sector with the Conservatives far more strongly

disposed to allow and encourage the mining and sale of

uranium.

Financials – another inquiry as pendulum swings towards consumer protection

Issue: Banking reform

Political risk: ‘Too big to fail’ guarantee removed or

extended to other deposit taking

institutions

Increased regulation and compliance

costs arising from new consumer

protection laws

As in most jurisdictions the banking sector remains at the

forefront of community and political debate and that debate is

“ … investors exposed to uranium mining in Western Australia need to be clear about which category of investor they fall into – locked in or locked out.”


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unlikely to cool in the lead up to a federal election. The sector

is already the subject of a Senate inquiry whose report is due

at the end of November but the far bigger challenge confronting

the industry is the proposal by the Conservatives for a Wallis

style inquiry if they win government next year. Such an inquiry

presents both threats and opportunities for the sector.

The Wallis inquiry was critical to introducing greater levels of

competition in banking. While more intense competition was

not necessarily welcomed by the then incumbents the effect

was to increase the overall size of the market by encouraging

innovation and thereby increasing the range of products and

services the sector could offer. The current profitability of

Australian banks is in part testament to the benefits of

competition.

However, those reforms, and the ones to follow such as

establishing the Australian Prudential Regulatory Authority,

also arguably limited some of the market opportunities for

banks. While the Australian sector is oft-cited for avoiding the

worst of US style sub-prime lending this was arguably a result

of tighter and more effective regulation and limited wholesale

funding access than the preferred lending practices of the

sector. While it is hard to quantify the impact of this regulatory

structure on earnings it is reasonable to assume that they

limited earnings by preventing riskier lending in the boom years

but also limited the downside of the global financial crisis to

Australian lenders.

Another comprehensive banking inquiry could have a similar

effect. The immediate effect may be to increase competition in


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the sector making the market more attractive to new global and

domestic players but could also increase the size of the market

through another burst of innovation thus increasing the

opportunities for all participants.

One way in which this may occur is through the removal of

what is effectively the ‘too big to fail’ guarantee provided by the

Government. This guarantee of unlimited support is available

to those institutions whose failure would constitute a systemic

crisis, one that would threaten the broader financial system.

This focus on stability by the Commonwealth Government

results in cheaper access to funds for those institutions

covered by the guarantee. According to critics the result is less

than optimal competition in both personal and business

lending.

A future government may level the playing field by either

removing the guarantee or extending it to a wider group of

lenders. Investors should note that this is likely to lead to

increased pressure on margins as the level of competition

intensifies and becomes more sustainable.

The inquiry could also bring increased regulation and costs.

The flavour of the current debate is heavily weighted to

consumer protection particularly in the home mortgage and

credit card markets. A major inquiry is likely to impose new

costs and limitations on the sector particularly in areas of

customer disclosure and consent, and resolution of hardship. It

is also likely that current calls from consumer groups for

enhanced customer switching mechanisms will also feature

heavily in forthcoming inquiries.

“A future government may level the playing field by either removing the guarantee or extending it to a wider group of lenders.”

“The flavour of the current debate is heavily weighted to consumer protection particularly in the home mortgage and credit card markets.”


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The effect of these decisions will not emerge in the next 12

months. Nonetheless, investors are confronted with decisions

about the sector that will be dramatically affected by the

outcome of a Coalition initiated inquiry anticipated in the first

half of 2014.

Telecommunications – politics and the online economy

Issue: National Broadband Network (NBN)

Political risk: Extended period of uncertainty until

the feasibility of Coalition plans to

adjust the NBN model are tested

Earnings risk for Telstra shareholders

if Coalition seeks to renegotiate

contracts

The greatest political risk for the telecommunications sector

over the next 12 months is the uncertainty surrounding the

National Broadband Network (NBN), which derives largely from

an expected victory for the Conservative parties and their

stated intent to cancel the NBN roll out and transition to a

private sector solution.

At first glance investors in Telstra are confronted with the

greatest risk. If taken at face value a Coalition win would result

in a review and renegotiation of existing contracts with the NBN

Co, which would affect expected returns on funds already

invested. However, Telstra may be entitled to compensation if


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the Coalition seeks to discontinue current arrangements

although any compensation under existing agreements will be

dependent on a level of progress / completion (e.g. 20%) that is

unlikely to be achieved by the time of the next election.

The good news for Telstra investors is that the Coalition is

committed to an NBN, albeit one that is more reliant on the

private sector. It is difficult to imagine that such a

telecommunications infrastructure project could be pursued

without access to Telstra copper, duct or fibre networks. This

means that any future plan is most likely to require the

renegotiation of existing contracts with Telstra rather than

cancellation.

For other players in the sector there may be opportunities

arising from a Coalition win. The biggest opportunity would

arise if the Coalition elected to broadly continue the rollout but

switch to an alternate dominant technology or a variety of

technologies. Providers of wireless connections in particular

could benefit from such a shift. However, as with the threats

the opportunities are clouded in uncertainty and dependent on

the extent of the rollout at the time of the next election.

“The greatest political risk for the telecommunication sector over the next 12 months is the uncertainty surrounding the National Broadband Network (NBN) ...”


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CONCLUSION

Elections create the very thing investors’ dislike the most

– uncertainty. Unfortunately, this is exactly the outlook for

investors in the Australian market over the next 12

months. While a Coalition victory is highly anticipated at

the next federal election there is always an element of

doubt in the democratic process.

However, even a Coalition victory will bring with it new

uncertainties, particularly if minor parties retain control of the

Senate. Stated intentions to make fundamental changes to

laws such as the carbon tax and NBN will count for nothing if

passage through the Senate cannot be assured. This in turn

may create more uncertainty if a Coalition Government decided

the deadlock could only be broken by another election, in this

case a double dissolution.

The uncertainty of elections will also emerge in the resource

rich state of Western Australia. Mining companies will be most

attuned to changes in policy if Labor were to win office but that

state’s revenue challenges expose all firms to some form of

risk, particularly new and / or additional taxation.

In response investors will need to actively monitor political

events and trends over the coming year and prepare for a

number of scenarios. They should also be mindful that as with

all types of risk, the emergence of political risk over the next 12

months creates opportunities as well as threats.

“In response investors will need to actively monitor political events and trends over the coming year and prepare for a number of scenarios.”


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ACKNOWLEDGMENTS

1 Francis, D, 2012, US News, What the Presidential Election Means for the Stock Market, 19

April 2012.

2 Anderson, H, Malone, C & Marshall, B, 2004, n.d., Investment returns under right and left

wing governments in Australasia.

Documents

Investing in an election year