Direct Capital’s Ross George is a pioneering veteran of the New Zealand private equity market. Now, 25 years after raising Direct Capital’s first fund, George is still going strong. He talked with Capital Markets about how he got started here as a 32-year-old, the dynamics of the market and some of his standout transactions.
Herald: You were very young when you came back to New Zealand to raise the first fund for Direct Capital — which you listed. Why did you make that decision to list and how did you have the confidence to do that at such a young age?
George: I was 32 when I came back. I did come back to raise the first fund for Direct Capital but it didn’t actually work on its first go. That was the early 1990s. New Zealand was quite depressed. There was huge distrust for investment professionals after the party of the 1980s and the private equity industry didn’t exist in New Zealand. There were a couple of venture capital funds including a Government one called Greenstone. We had to educate investors what private equity was. It was called direct investment back then.
I then convinced my varsity mate Mark Hutton to come back from Monaco to join Direct Capital and Bill Kermode, who I knew from school, to do the same. It got off the ground once the three of us teamed up. We were all young but we had confidence because I came from the industry, Mark was in a senior financial position in Monaco and Bill was well known in Wellington where all the institutions were.
The listing was a happenstance. We planned a private fund of $50m which was quite a lot at the time. The listing came about in a funny way actually. I was doing a presentation to about eight people in AMP in Wellington in the middle of which they all started talking amongst themselves and then gradually one by one got up and left. I did the second half of the presentation with a couple of analysts who were over compensating by nodding a lot. Towards the end the big bosses came back in and said “if you can write us a good proposal and agree to list it, we will put $25m in”. That was enticing but it put at risk the only money we did have at the time which was from the Bell South Pension Fund whom I knew from Hong Kong. We actually lost Bell South as a result of the listing decision. But AMP were quite a bell cow for other institutions and we listed with over 10 institutions on board which was a great effort. The other positive of the listing route was we appointed Rob Morrison and Ord Minnett as brokers who did a fantastic job for us.
Herald: In the last few years Direct Capital has transitioned from the three tight partners — Mark Hutton, Bill Kermode and yourself — that ran the fund over the first 20 years. What made you decide to continue after their exit?
George: Yes, it was a great partnership and we are still joined at the hip in a number of investment vehicles.
While Bill left, Mark is still an owner, a director, and on the investment committee. He is not a full time executive but remains actively involved.
It’s actually been a continual succession process since we started through Gavin Lonergan, Tony Batterton, Simon Plowman through to the current owners, Travis Sydney, Heath Kerr, and Andrew Frankham. Hugh Cotterill, our new partner joins in June. We have got very good at succession because we have watched it in a lot in companies we invest in.
I have continued on because I enjoy the work. It is like a university course where continual learning is the norm. You can be dealing with a pharmaceutical company one year, then a logistics company, a retirement village operator, an internet market place and an engineering firm the next. The commonality between them all is growth which is our focus. The rules of growth seem to be the same no matter what industry you are in. The easiest growth we have found to be is in Australia. For the last 20 years about 50 per cent of our revenues have been derived in Australia. Once you know it, it is a very good and successful market to be in.
Herald: Looking back over 25 years, what has been your stand-out performer?
George: We don’t typically highlight individual companies but we’ve listed some of our companies and their performance is public record. Ryman Healthcare has been an obvious highlight. We invested in it in 1996 when it had a small number of South Island retirement villages. The industry wasn’t that understood at the time as it was in its infancy. The people however were the best we had seen. John Ryder and Kevin Hickman had almost all of the bases covered between them. They had different skills but they were good mates and a great business combo. It wasn’t a popular investment at the time as people thought of it as property development. The drivers of this industry are far from it and we think they still are. Building the villages is a short period within a retirement village’s life. It is a people and healthcare industry once it is up and running.
John and Kevin wanted additional capital so they could accelerate what they knew to be a successful business model. It worked almost immediately. Ironically we had trouble listing it and there was reluctance at an institutional level to invest. Fortunately we knew all the institutions at the time and after a series of one-on-one meetings we got a sufficient number on board to proceed. Once it was on the market it didn’t turn into a darling for its first two or three years. We invested at an equity value of $23m! Its market cap hovers around $5 billion to $6b now.
We are very proud of Ryman and to complete the circle John Ryder is now non-executive chairman of Direct Capital, and just to complete another circle, we have re-invested into the retirement village sector alongside John in Qestral Corporation.
Herald: Scales Corporation is absolutely booming. You scooped it up from the South Canterbury Finance receivership in 2011, later listing it on the NZX — which paid off very well. Was that investment always a no-brainer?
George: We knew Scales very well for 5 — 10 years before we got to invest in it. In fact, our offer to invest in 2011 was our fourth attempt. We could never get the (Allan) Hubbard Group over the line.
It was put up for sale through the South Canterbury Finance (SCF) receivership and ironically (again) we absolutely struggled to get into that sales process.
The receiver had high valuation ambitions and Goldman Sachs thought we had insufficient money to buy it. Although that wasn’t completely true we understood their view so teamed up with ACC and NZ Super in a consortium and were then allowed into the process. We knew Scales was not a straight forward investment for anyone unfamiliar with it and we knew it had been tied up in the South Canterbury Finance group which would scare others off.
We didn’t really scoop it up because we think 28 parties were approached and one by one they fell away through the process. Commentators also tend to ignore the high level of debt in the business at the time which we reduced over time. It wasn’t “scooped up” on an enterprise value basis. In any event, we clearly had the most attractive offer at the end which was well financed. I also think we were attractive to Andy Borland and his management team because a number of other bidders only wanted one division of it and our offer was for the whole lot.
Scales is a great company which again has a great group of managers and that is why it’s successful. The investment was in no way a no-brainer in fact it was a very difficult investment to make for all of the reasons above.
Herald: Which company has been the biggest turnaround challenge?
George: It’s one of the most common questions we get asked and we always disappoint by not answering it but the simple truth is that we are always investing into private companies alongside other shareholders, often family groups, and management and our partners are usually quite private individuals. They expect their privacy to be respected and we honour that. In fact, many owners tell us that is the reason they prefer private equity over other options.
But of course very few businesses travel in a straight line of success. Private companies are just as subject to economic and business cycles as anyone. When business gets difficult it is often due to changes in industry structure or risks that do in fact eventuate. Occasionally you have to accept that what you invested in is different to what you thought it was. Thankfully we have delivered very good returns to our investors for 25 years because those situations are the exception, not the norm. When these situations do occur you have to ensure you have the right information to evaluate whether more capital will solve it, or more time. And sometimes it is neither. Investment is rarely a binary “good call or bad call,” it is managing identifiable risks and being patient when required.
One of the reasons private company investment is so successful is the alignment of interest between shareholders and management. In private company investment you invest alongside the owners and management.
Everyone has skin in the game. Both we and they have a vested interest in solving business issues when they arise, rather than management just moving on to the next career assignment. In our view this alignment of interest is one of the most powerful drivers of value in private company investment.
Herald: What have been the lessons you have learnt from an investment that hasn’t gone so well?
George: We invested in a people based company with five owners. We only discovered after we made the investment that only three of them were keen on expanding the partnership to include us.
It was difficult for those five and us but we managed our way through it. It wasn’t a financial success and it shows the value of a harmonious partnership. It’s easier to run a company when all the owners are on the same page.
The lesson out of this was to spend a lot more time with all the owners before investing to find out everyone’s motivations. Nowadays, we ask our prospective partners what their objectives are and we can handle almost every variable we are faced with — ie do they want to stay in the business for ever, do they want out, do they want to be part-time or more flexible, do they want to change roles etc. We can accommodate all of this as long as we know it.
Herald: You hold a retreat every two years where you get all the companies you have invested in together. What’s the rationale behind that?
George: We have held 13 of them and I think they look forward to them as much as we do. Direct Capital doesn’t buy a business, it invests into a company with other shareholder owners so you get quite close to the people you are in business with. Fortunately in a growth company it is also quite good fun and over time you get to like each other and since you have dealt with a myriad of issues in the trenches you know each other really well. The most extraordinary thing is that the people we invested alongside in the early 1990s still come, and they become mates with all the other companies.
Our partners are a group of similar people who enjoy catching up with each other.
We try to make it mostly educational during the day with drinks and dinner and some form of entertainment at night. They never know where they are going and just agree to meet in the morning at a café.
Part of the rationale is that companies we have invested in in the past are our best form of marketing to other company owners. In New Zealand everyone checks each other out and if you don’t check out well you don’t have an enduring business here. They all speak well of us and this conference is also to say thank you for that.
Herald: How has the New Zealand private equity market changed over 25 years?
George: The market has come a long way and is now professionalised with funds being run by experienced and proven management teams. In 1994 it wasn’t really an industry. In addition to the NZ-based managers we see Australian and international funds also active in the New Zealand market.
There’s also been the development of Limited Partners — institutional funds who now allocate capital to the private company market as a matter of course. And it’s not just the evolution of General Partners and Limited Partners — we’ve seen the banking, legal and advisory community grow enormously to service the industry.
And a huge benefit of this is that company owners have also become much more familiar with private equity and understanding of the benefits a financial partner can bring to their business. This was something we used to have to explain to them. Today, a sell down or introduction of a financial partner is a common and accepted (and often preferred) option for business owners thinking about growth or capital.
The operating standards of private equity firms have also advanced through the influence of Limited Partners, who are all part of global networks. Direct Capital operates to international standards in terms of reporting, governance, identifying and managing environmental, social and governance issues (ESG). We were the first New Zealand private equity manager to become a signatory to the United Nations Principles of Responsible Investment (UNPRI).
Herald: You’ve said previously that the private company market is at least 10 times bigger than the listed company market in New Zealand. What does the NZX need to do to build confidence for public listings?
George: We are involved in the Capital Markets 2029 Taskforce currently underway and are very supportive of NZX initiatives to deepen our public markets. We don’t see private equity as a competitor to the NZX.
We are complementary to each other. We have led the IPOs of several of our companies — Ryman, Nobilo Wines, Scales, and New Zealand King Salmon and would expect to list others over time.
I think the first thing to acknowledge is that not every private company can be listed or indeed wants to be listed. As I mentioned, private company owners are often family groups or comprise a small number of shareholders and are quite private people.
Company owners often have strategies that will take several years to execute. When listed there is a natural focus on more immediate performance. Owners often express a concern about their ability to remain focussed on longer term growth initiatives in a public environment. It’s a common issue in the US and around the world.
Beyond that, a broader market of public market intermediaries would be helpful. We have seen the benefit of that in the private company space and I believe the same would be true for the listed sector.
Herald: What are your predictions for the private equity market over the next five years?
George: We are 25 years old this year and have invested in 75 companies. In the larger mid-market area that we operate in we know there are close to 1000 private companies that are of a size that we could invest into. We’ve barely scratched the surface. Of course those companies need a catalyst to introduce a financial partner — whether it is to fund growth or succession. I think the next five years will be a continuation of the past 25 years.
Capital will continue to accelerate growth. In our 25 years, the benefit of new capital into business has been clear.
Our companies, in aggregate, have grown their employee numbers by 44 per cent and revenue by 64 per cent. Inevitably we will see a cyclical correction — probably sooner than later. But we’ve been through a number of those periods in our 25 years and good businesses with good management teams, and that are well-capitalised will continue to thrive. Indeed, investing in cyclically difficult times has proven to generate the greatest value in our experience.
We’ll see second generation managers emerge and that will be a healthy sign of a continuing maturity in our market. I’d like to think we’ll see more institutional investment into private companies.
KiwiSaver is the obvious elephant in the room for its lack of investment despite the positive international evidence of pension funds in the space and the natural compatibility of the investment timeframes.
KiwiSaver is now at a scale where issues such as the requirement for liquidity and pricing on a daily basis, for example, are not that credible for what would be a small percentage of overall asset allocation.
There is no doubt, New Zealand’s private company sector continues to provide excellent opportunities for experienced managers to accelerate growth and generate investor value. This is confirmed by an array of institutional investors continuing to consider increasing mandates targeting private capital in New Zealand.
Tour highlights the importance of a clear vision and well-communicated long-term infrastructure plans
Each year, New Zealand’s peak infrastructure body Infrastructure New Zealand leads a delegation of senior public and private sector leaders overseas to explore new ideas and approaches to delivering infrastructure.
This year, the delegation travelled to Singapore, Hong Kong, Beijing and Shanghai to investigate road pricing, integrated transport and urban development, new cities development, and national, regional and city planning. Infrastructure Minister Shane Jones travelled as part of the delegation for the first week.
Industrial and Commercial Bank of China (ICBC) New Zealand helped to co-ordinate the Beijing part of the itinerary, which included sessions on China’s national, regional and city governance; China’s economy and infrastructure funding and financing; Beijing’s masterplan and transport system; and how China looks at prioritising its investment planning.
Xiong’an: green, intelligent and liveable
As part of the Beijing leg, delegates took a day trip to nearby city Xiong’an. The Xiong’an New Area, announced in 2017 and about 100km southwest of Beijing, is destined to become the location for many of Beijing’s non-capital functions and — in turn — home to its relocated population.
At the time, President Xi said the most important role of the Xiong’an New Area was “to help phase out functions from Beijing that are not related to the capital, explore a new model of optimised development in densely-populated areas, and restructure the urban layout in the Beijing-Tianjin-Hebei region.”
Almost immediately, comparisons were drawn between Xiong’an’s future and the southern city of Shenzhen and Shanghai’s Pudong area. Shenzhen — now a leading global technology hub and one of China’s richest areas — greatly benefited from the rapid foreign investment following the economic reform and “opening-up” in 1979. Shanghai’s Pudong is home to many of China’s most iconic skyscrapers, and remains one of the country’s most successful development projects.
Early this year, the 2018-2035 master plan for Xiong’an New Area was approved by China’s central authorities. According to the plan, Xiong’an will be transformed into a green, liveable and modern urban area designed for the modern economic system, with “relatively strong competitiveness and human-environment harmony by 2035”.
Says Amanda Lu, ICBC New Zealand’s deputy CEO: “The New Zealand delegates were very impressed with the way China plans long-term for the future. They are able to attract investment and implement massive infrastructure projects based on a long-term strategy where everyone is aligned to deliver on the future goal.”
“The areas we visited — Singapore, Hong Kong, Beijing and Shanghai — all have a clear vision of the future and long-term infrastructure plans which are well communicated to the public,” she says.
“There are educational hubs set up to help the public and professionals understand the national strategy, city planning, urban development and architecture. The public is brought along on the journey and can see that the outcomes promised are actually delivered.”
ICBC’s fintech focus
Reinforcing the commitment to Xiong’an’s focus on fintech development, ICBC has this month announced a new fintech research centre in Xiong’an. Named the ICBC Information and Technology Co. (ICBC Technology), the new centre is using a capital injection of 600 million renminbi (NZ$134m) to focus on high-tech software and product innovation in fintech.
The Xiong’an New Area Regulatory Commission also officially launched the Xiong’an Requisition and Resettlement Funds Management Blockchain Platform, which applies ICBC’s blockchain technology to the management of the entire process of requisition filing and disbursement of funds.
ICBC group chair Chen Siqing says ICBC Technology will leverage ICBC’s financial and technological advantages to integrate innovative capability and create smart banking strategic measures.
Chen highlighted the “openness genes” of ICBC Technology, with the company expected to serve as a key support for ICBC’s open financial services concept and the implementation of open operations and IT frameworks.
“On the foundation of optimising existing tech institutions, ICBC will use the establishment of a tech company to accelerate and expand the value chain of its own product and services,” he says.
“Following the establishment of ICBC Technology, we will establish specialised, market-based operating mechanisms that suit the demands of fintech development, and explore new models and paths in the areas of innovative R&D, talent incentivisation and the integration of industry, academia, research and application.”
Green panda bonds
A green panda bond is a renminbi-denominated bond issued in mainland China by a foreign entity, with proceeds earmarked for green assets or projects. In issuing a green panda bond, both the regulatory requirements for panda bonds and those for green bonds need to be followed — the bonds must finance eligible green assets that promote the transition to a low-carbon and sustainable economy, and provide clear environmental sustainability and climate change benefits.
Lu says green panda bonds provide an opportunity for overseas green bond issuers looking to diversify their investor base. The booming China green bond market will help fund the investment required to transition to a low carbon and climate resilient economy.
“There is a famous Chinese saying: ‘a fence needs the support of three stakes, and an able fellow needs the help of three other good fellows’.
“It is only through a joint effort and by working together that we will be able to create a sustainable future.”
Tim McCready breaks down the numbers in EY’s investment report.
The annual EY Private Equity & Venture Capital Monitor was released this month, and was characterised by a record level of overall activity of $1.7b in the year to 31 December 2018.
This was an increase of $709.3m from 2017’s $989.6m, and significantly above the $870.2m average since the survey began in 2003.
Total investment activity in 2018 was $1.1b, spread across 62 deals. This was up $218m from 2017, driven by a higher average deal value in 2018 ($17.6m) compared to 2017 ($12.9m).
“Private capital is an important aspect of the New Zealand economy, because it represents a larger proportion of the overall capital markets than in other geographies,” says Andrew Frankham, chair of the New Zealand Private Capital Association.
“The Monitor illustrates the availability of private capital in New Zealand remains healthy, with renewed interest in early stage investing and continued strong activity in the mid-market investment space.”
Mid-market investment activity
Mid-market investment activity remained buoyant in 2018, resulting in $245.0m in investments, though this was down on 2017’s record high of $333.7m. Average investment value decreased from $19.6m in 2017 to $12.9m in 2018, a return to the longer-term average trend.
Mid-market transactions in 2018 included investments by New Zealand domiciled funds including Direct Capital, Maui Capital, Milford Private Equity, Pencarrow Private Equity, Pioneer Capital, Oriens Capital and Waterman Capital. There was also an increased level of activity from funds outside Oceania.
Divestments in the mid-market showed an increase from 2017, primarily driven by transactions of Australian funds. “The sector continues to be a strong performer with more than $1.9 billion invested in the past decade and $976 million returned to investors to date,” says Frankham.
Rocket Lab ensured technology remained the dominant sector for VC in 2018. Other sectors obtaining investment in 2018 included food/ beverage, and health/biosciences.
Respondents to the Monitor’s survey were asked to identify which sectors they were most optimistic and pessimistic about. Food/beverage (31 per cent) and health/biosciences (25 per cent) both continue to generate significant optimism. The standout sector causing pessimism was media/communications (46 per cent).
The Monitor showed a slightly more positive view of the next six months compared to last year.
Respondents were largely optimistic. This reflects the economy’s relative resilience compared to global markets. Over the next 18 months, the outlook is still slightly improved from last year.
“Investment in New Zealand’s private companies continues to provide excellent opportunities for experienced managers to accelerate growth and generate value for investors,” says Frankham. “A number of local institutional investors continue to consider increasing mandates targeting private equity.”
Fund managers were asked to highlight key factors they consider will impact their activity in New Zealand over the next 12 months.
● Venture capital respondents noted: achieving successful exits, availability of capital, and the potential impact of Government policy.
● Private equity respondents noted: level of “dry powder” and competition for assets driving higher multiples, ability to hire skilled and experienced employees, potential impact of tax changes on investor participation, and increased opportunities from ageing vendors seeking succession.
Colin McKinnon, executive director of the New Zealand Private Capital Association says:
“The mid-market and the angel network are demonstrating consistent and healthy deepening of the private capital market. The emerging prospects for additional formal venture funds are pleasing.
International investor interest in New Zealand companies across all stages continues to provide New Zealand’s private markets with opportunities to grow quality companies and management teams.
“Private capital assists in accelerating growth ambitions of New Zealand businesses. Growing businesses with capital and expertise improves productivity, which is good for New Zealand.”
A rocket for venture capital
The total value of disclosed venture capital and early-stage start-up deals in New Zealand for 2018 was a record $269.7m, spread across 40 deals.
This compares to $217.3m across 48 deals in 2017, and represents a notable increase in the value of New Zealand venture capital activity.
The headline deal was the additional capital raised by private New Zealand aerospace technology company Rocket Lab, which operates the world’s only private commercial orbital launch site. There was also a continuation of smaller scale deals consistent with prior years. New Zealand’s domestic early-stage venture space continues to be challenged by a shortage of capital available for series A and B capital raisings.
But Frankham says it is pleasing that in the last year we have seen the emergence of a number of teams with a particular skillset to execute in this niche environment.
“New investors from angel investors to KiwiSaver funds are taking renewed interest in aggregating capital into venture funds, with a recent example being the announced Icehouse Ventures Fund,” says Frankham.
Adapt or die: financial organisations will have to alter their business models to keep up with the changing landscape, writes Tim McCready.
The mobile phone revolutionised the way people engage with their bank, and in the years since, the emergence of more technologies are further shaking up the banking sector — including blockchain, artificial intelligence and big data.
A report from the US Treasury says between 2010 and 2017, more than 3330 new US technology-based firms serving the financial services industry were founded.
Consulting firm EY says half of US consumers now use fintech firms to transfer money rather than traditional methods. This rapid growth is said to be unsettling officials, particularly as young players are perceived to favour rapid growth over risk-management and regulatory compliance.
At this year’s Asian Financial Forum, executives from leading banking, payments and technology companies provided insights into how fintech is transforming their businesses. Though there have been concerns fintech could wipe out traditional finance firms, participants shared how their companies have adapted, the lessons learnt from their evolution.
“There is a perception that conventional banking has been left behind, and fintech is considered a different stream,” says Diana Cesar, group general manager and chief executive, Hong Kong at HSBC.
Cesar disagrees that upcoming fintech companies will displace traditional banking, and says HSBC has been adopting technology for years. But she acknowledges a shift in terms of how technology is applied — the customer is now centre stage when decisions are made by the bank.
“The shift has gone from operations — things like strategic modelling and credit scoring — to how we can enhance the customer experience and journey.
” There is an increasing focus on using data to better understand the customer and offer a service more tailored to their needs.
Cesar explained that when HSBC embarked on this journey, it was used to a servicing model:
customers would use a bank during office hours, and phone banking after hours. “The world has evolved — information services are at everyone’s fingertips on their mobile phone.”
Openness and inclusion
Corporate vice-president, chairman and CEO of Microsoft Greater China, Alain Crozier, says over the past decade Microsoft, already a leader in the industry, was forced to redefine its mission and culture to be much more customer-oriented.
“A major culture change was to open the mindset of our employees. Not just provide technology for technology’s sake, but bring the best for our customers, no matter where they are.”
Crozier says “what was yesterday’s competitors have become today’s customers”. He says Microsoft is opening up its technology so it can be integrated with all other technology.
“The notion of openness and inclusion is fundamental. The power and development of new services will come when you bring data together in one common platform that will help serve customers better.”
Shirley Yu, group general manager for Visa Greater China agrees: “Visa believes in collaboration. It is critical not to restrict others from coming into the market, but making sure we have standards that ensure there is interoperability.”
She points out that even though Visa was formed 60 years ago and could be considered the original fintech business, its ability to adapt means it remains among the biggest.
“If you look at our organisation, more than 50 per cent of our people are in technology,” she says.
“We went public 10 years ago. In the last seven years we have tripled our market cap because we are transforming and changing how we serve our clients.”
Yu says Visa’s core competency is scale; it has 47 million merchants in 220 countries that use its service.
She says Visa is open to new technologies and willing to collaborate with fintech organisations because although the new technologies can be disruptive, Visa can leverage its scale and provide new ways to serve its clients. In order to stay ahead, Yu says Visa is prepared to change everything it does — including its business model.
As an example, Visa has traditionally focused on serving the most affluent.
Yet studies the company has conducted into millennial behaviour have shown younger generations are not attracted to the traditional Visa rewards programme.
“If we focus on the affluent it brings a lot of business for us, but we have to capture millennials today, to make sure we capture their life cycle,” says Yu.
“They want instant gratification — so we’re rethinking how we design loyalties.”
From batch to real-time
Tony McLaughlin, Managing Director, Emerging Payments and Business Development, Treasury and Trade Solutions of Citi, says changes taking place in the payments field are “visible and stark.”
He says cryptocurrency and other distributed ledger technology present a radical vision of the future of money, which could ultimately lead to a re-engineering of the fiat currency system.
But the other major change McLaughlin has seen implemented by many countries in a much quieter way is real-time payment systems and open banking.
“Cryptocurrency is the noisiest development, but the true story is the quieter movement from batch to real-time — that’s where the real action is,” he says.
McLaughlin explains banks are still built on batch processes, which doesn’t marry up well with real-time banking. Payment systems like AliPay, WeChat Pay and open banking in the United Kingdom are all part of the shift towards a 24/7/365 system.
He says the concept of end-of-day and cut off times are all artefacts of batch processes, and the transition into real-time is going to be enormously challenging.
“Organisations can delude themselves for a long time milking existing business models.
“In this day and age, banks must see the writing on the wall if they don’t adapt,” says McLaughlin.
Earlier this year I travelled to Hong Kong to attend the Asian Financial Forum.
The forum, now in its 12th year, brings together financial and business leaders, global policymakers and financial regulators from over 40 countries and regions.
While the theme of the Forum this year was “creating a sustainable and inclusive future,” it was unsurprising this was clouded by the uncertainty hanging over the United States-China trade negotiations, fears of growing protectionism, populism and wider geopolitical tensions.
In her opening address, Hong Kong’s chief executive Carrie Lam wished attendees success in finding innovative new ways to excel in 2019 — but acknowledged it will likely be a considerable challenge this year.
She was, of course, referring to the trade discord between the world’s two largest economies — as well as lingering uncertainties in other parts of the world.
“For many economies — including Hong Kong — moderated growth and, for many companies, diminished business and financial results appear inevitable,” she said.
The more than 3300 attendees agreed — the audience were given the chance to vote on sentiment throughout the forum.
When asked about the outlook for the global economy in 2019, just 15 per cent of respondents were optimistic; 47 per cent were pessimistic. This is in dramatic contrast to the 2018 Forum, where 58 per cent were optimistic and just 6 per cent were pessimistic
A follow-up question asked the source of risk for global financial stability this year: US-China trade tensions came out on top with 77 per cent of respondents.
This was followed by monetary policy normalisation (10 per cent), cyber breaches and security risks (7 per cent) and Brexit and fiscal discipline in the European Union (6 per cent).
Perhaps in light of the concern around China uncertainty, attendees at the forum felt that Southeast Asia offered the best guarantee of investment return for 2019 (39 per cent). This was followed by China (35 per cent), the United States (16 per cent), Japan (3 per cent) and Western Europe (2 per cent).
Hong Kong’s Financial Secretary Paul Chan said that global uncertainty weighs heavily on global investment and business sentiment, and adds downside risk to economic growth and increased volatility in financial markets.
Although Hong Kong is part of China under the “One Country, Two Systems” principle, it has distinct advantages for attracting investment — including operating with a strong rule of law based on English common law, independence of the judiciary, a simple tax system, and respected intellectual property protection.
Chan said Hong Kong’s position as the freest economy in the world comes with an assurance that protectionism won’t happen there.
“We support free trade and the multilateral trading system, as well as the free flow of capital, people and information.
“Indeed, it is the cornerstone of our economy,” he says.
“The International Monetary Fund has commended Hong Kong’s prudent macroeconomic policies.
“The fund noted that our long-standing buffers will help Hong Kong maintain stability despite the increasing risks confronting global growth.”
He noted that the Government is enhancing the regulatory regime and the resilience of the financial markets to help Hong Kong maintain financial stability amid heightened external uncertainties.
But US-China trade tensions, the economic slowdown in China, cooling property prices and volatility in the stock market have had a demonstratable impact.
The trade-reliant Hong Kong economy expanded at just 1.3 per cent in the fourth quarter of last year — significantly down on the 2.9 per cent GDP growth recorded in the third quarter.
Export growth was near-zero, a dramatic decrease from the 6 per cent average in the first three quarters. Retail sales were also down.
Denis Beau, First Deputy Governor of the Bank of France, told the forum: “the world economy is facing a maturing financial and economic cycle, but we are far from a downturn”.
Overall, financial intermediaries were much better equipped to withstand shocks than during the financial crisis in 2008.
Burkhard Balz, executive member of Deutsche Bundesbank (Germany’s central bank) said uncertainty was significantly higher than 20 years ago — due to disintegration (referencing Brexit), political disturbances and trade tensions — but “by historical standards, volatility is not high”.
Other keynote speakers, including Vice-President of the China Banking and Insurance Regulatory Commission, Wang Zhaoxing, recognised that despite the challenges, there were still many opportunities.
He was confident the Chinese economy would remain stable because of the potential for supply and demand in the country and said although the opening up of China’s banking and insurance sector had so far been gradual, President Xi announced an acceleration which has been welcomed globally.
Wang said China’s central government would focus on five key areas this year: the real estate market, local government debt, the influence of global markets, monetary policy in developed countries, and the trade relationship between China and the United States.
“China will continue to work with other Asian countries to strengthen collaboration and promote the development of the Asian economy and financial markets,” he said.
In response to the Forum’s theme, participants were polled on what the biggest challenge was to achieve a sustainable future globally.
A total of 43 per cent said it was a “reluctance to trade higher cost today for better sustainability for future generations”.
This was followed by “reluctance by some governments to adopt policies for sustainable development” (23 per cent), “insufficient attention to environmental, social and governance factors in asset markets” (21 per cent), “lack of financially viable green projects” (10 per cent), and “lack of green funding” (3 per cent).
Tim McCready travelled to the Asian Financial Forum as a guest of the Hong Kong Government.
Tim McCready talks to James Fok, Head of Group Strategy at the Hong Kong Exchange
Herald: What sets the Hong Kong Exchange apart from other exchanges around the world?
Fok: We’re one of the top several exchanges in terms of market capitalisation in the world. We have been number one in IPOs in six of the last 10 years. In many ways, we have a fantastic business — particularly leaning on mainland China and helping Chinese companies from the 1990s onwards raise capital from international markets. Unlike many other cash equity exchanges around the rest of the world, we have quite a lot of growth in our core business. While in New York you’re seeing the number of listed companies fall year-on-year, we’re seeing the number of listed companies go up.
Going back almost 10 years now, we recognise that mainland China is also changing in the way in which it operates and is structured. The first H-share company [companies incorporated in mainland China that are traded on the Hong Kong Stock Exchange] to IPO on the exchange was Tsingtao Brewery Group in 1993. At that time there wasn’t a lot of capital in China, so if Chinese companies wanted to raise capital they had to come out into international markets, and Hong Kong was a place that enabled them to do that.
Herald: With China opening up over past decades, how has the Exchange’s relationship with China changed?
Fok: Today there is a huge surplus of capital in China — notwithstanding the economy slowing down. There is over US$25 trillion sitting in Chinese deposit accounts that has not been deployed into capital markets. We still see a big opportunity with China, not necessarily with Chinese companies coming out to raise capital — although they are continuing to do that — but to try and find a way for Chinese investors to be able to diversify their investment in international markets.
Chinese financial market needs are also becoming a lot more complex. Chinese companies and individuals are doing a lot more things internationally, and supply chains are such that they are making sure they squeeze every bit of margin out of everything. That means they have to hedge a lot of the input prices such as metals and commodities. China is rich in many ways, but in terms of natural resource commodities it is generally having to import to supplement its own domestic production. On top of that, doing more business internationally means that there is foreign exchange risk, interest rate risk on foreign currencies, etc.
The role Hong Kong needs to play going forward is a much more comprehensive one. Not just the capital formation centre that we have continued to be, but we need to become a wealth management centre and a risk management centre for China as well. International investors coming here continue to come here for the Chinese exposure. They now have the option of going to the mainland directly, but many still find challenges in going directly onshore.
Now, as well as bringing Chinese companies here directly to list, the exchange is helping to provide a channel in which investors on both sides of the border can access each other’s market without the product or company being directly listed there.
We are providing a gateway for people to go in using their broker in Hong Kong — without having to open new accounts onshore — allowing access to the onshore market in as frictionless way as is possible, where we manage the differences in market structure.
Equity is still a large piece of the business, but more and more we have been shifting towards different asset classes as well — the most obvious was our acquisition of the London Metal Exchange in 2012.
Herald: How are new advances in fintech reshaping how you’re operating?
Fok: Stock exchanges are the original fintech businesses. Technology has driven our business for a very long time. But what seems to be happening at the moment in the technology space is that we have a confluence of factors that are forcing a huge acceleration in the pace of change.
That change, in many ways, has been hugely disruptive. You only have to look at retail businesses and what Amazon has done to those to understand that. When you look at stock exchanges and you look at the fundamental business model — providing a centralised place for people to buy and sell securities — generally that model is very efficient. But in every other facet of our business — ranging from clearing and settlement, the ways companies communicate with their investors, through to the day-to-day operational processes — that is now disrupted.
When you look at the ability of robotics and artificial intelligence to replace a lot of fairly menial — and actually relatively sophisticated but process-driven jobs — it’s phenomenal. We have had to, like everyone else, look at how we adopt technology into our business to drive efficiency.
Many businesses do this as a way to cut costs. There is an element to which that is true for us, but actually it goes much beyond that. Because everyone investing in our market has to use us, if we are inefficient as a market and as an infrastructure, it imposes a significant cost on all the market participants which ultimately affects Hong Kong’s competitiveness.
Herald: How is the exchange helping to attract smaller start-ups to Hong Kong?
Fok: Last year we undertook the largest set of listing reforms we have done in 25 years. We launched three new chapters of our listing rules — all of which were targeted at new economy companies, but two in particular:
We launched a segment of our main board that caters to pre-revenue biotech companies. Many R&D companies when they come to market don’t have revenue, let alone profit. The biotech board allows companies from the biotech sector to come here and list. Prior to these changes companies had to at least have revenue.
The second component is to allow weighted voting rights. These allow founders to maintain control even if they are diluted below 50 per cent of the shareholding of the company. We didn’t offer these kinds of governance structures here, so we saw a lot of Chinese companies in the tech space find themselves in the US market.
We were number one for IPOs last year for the amount of money raised, and 32 per cent of that money raised came from companies listing under the new chapters.
Herald: The Hong Kong Exchange signed a Memorandum of Understanding with the NZX early last year. What was the purpose of this for the HKEX?
Fok: The long-term ambition for us is to develop the product offering in Hong Kong more widely. It is largely an equities market still today, and when you look at trading and market capitalisation, something like 80 per cent of turnover is on mainland Chinese companies. While this is precisely what attracts international investors, as we open up to more direct mainland China investors who already have a lot of China product to invest in onshore, we need to diversify our offering.
New Zealand isn’t the only country we have signed an MoU with.
Of course, on the stock side, New Zealand is not one of the highest priority markets — most Chinese investors looking to diversify will look to the US market. Instead, the purpose is to bring a more diverse range of products to the exchange. New Zealand has done very well in the agricultural milk future space — something that is potentially of relevance to mainland Chinese consumers, particularly given their consumption.
The NZX and Hong Kong (HKEX) exchanges signed a Memorandum of Understanding in January 2018 to further promote confidence and co-operation in Asia-Pacific markets. Under the terms of the memorandum, the exchanges seek to promote market development by considering opportunities in a range of areas, including foreign investment, derivatives, depository receipts, listed debt, dual listings and exchange-traded funds.
The NZX says:
This global alliance supports NZX’s commitment to increase its international presence, and our desire to expand the reach and connection of the New Zealand market, because growth in New Zealand’s public markets will come from having a wider range of listed products and increased market activity. Global alliances we initiated and are continuing to build with the Hong Kong, Singapore, Shanghai and Nasdaq exchanges support this.
NZX and HKEX have continued to work together since the memorandum was signed in January 2018. In April, NZX Regulation recognised the regulatory regimes and requirements for the Hong Kong, Singapore and Toronto exchanges. This allows companies listed on these exchanges to seek a secondary listing on NZX.
Seeking new ways to retain and attract customers has been a priority for NZX. It is vital to growing New Zealand’s public markets. Over the past 12 months, we progressed alliances with global peers to ensure that an NZX listing connects New Zealand issuers with the world.
Our relationships with the Nasdaq, Singapore, Hong Kong and Shanghai exchanges, and the transformation in our service offering to issuers, ensures we are developing a product that is relevant and competitive.
We’re in the midst of important structural shifts, says former World Bank President Robert Zoellick. Tim McCready reports
“China has had enormous progress over 40 years. It has had the most historic reduction of poverty in humankind,” says former World Bank President Robert Zoellick.
Zoellick, who led the World Bank through the global financial crisis and served as a US trade representative under President George W. Bush, points out that while Asian growth rates have been healthy, they have not been able to return to the levels they had before the 2008 financial crisis.
At the recent Asian Financial Forum he sent a message that the Asian growth model that was so successful for many decades would need to change.
Zoellick says Asian economic policymakers have traditionally had a longer time-horizon.
“The old model began by relying on manufacturing at the low end of supply chains. It then integrated upward — adding efficiencies, learning, productivity — but relied on the assistance of exports to developed economies.
“I think that perspective is especially valuable today because we’re in the midst of some very important structural shifts.”
Though Asia has accounted for two-thirds of global growth in recent years, markets are nervous as major shifts are taking place: the end of the quantitative easing experiment and transition to a tightening cycle, slower growth in real trade over the past decade compared to the 20 years before the financial crisis, productivity increases in Asia, and the ongoing trade dispute between China and the US.
“Trade policies and rising economic nationalism around the world have disrupted commerce and created a great deal of uncertainty,” says Zoellick.
“Traditionally, governments put tariffs on final goods, but from 2010 to 2016 they focused on temporary trade barriers, targeting cross-border supply chains for raw materials and components.”
But while President Donald Trump’s hefty tariffs may have been intended to help US manufacturers by making foreign goods comparatively more expensive, in reality, import taxes imposed on intermediate goods like steel and aluminium are pushing up prices of products manufactured in the US.
Belt and Road part of a new era
Zoellick says Japan, South Korea and Taiwan all offer cautionary tales — a bias towards incumbency and instrumentalisation has slowed the innovation process — and a rapidly ageing population and lower population growth are changing the dynamics. “We can see some of those trends in China today as well.
“One of the main challenges is: will Asia grow old, before it grows rich and wealthy?” he asks.
He says the new Asian model will need to focus on new and different types of supply chains, to meet the changing needs — first off — of the region itself.
He points to the Greater Bay Area as an example of how this transformation has already started in Hong Kong and China.
The Greater Bay initiative, established by the Chinese Government, links Hong Kong, Macau, and nine other cities within the Guangdong Province into an integrated economic and business cluster.
The 11 cities have a combined population of close to 68 million people — greater than the world’s largest city cluster of 44 million in Tokyo — and a GDP of around US$1.4 trillion (NZ$2.06 trillion).
The 55km Hong Kong-Zhuhai-Macau bridge-tunnel system which opened last year cut the drive time between the cities from up to three hours, down to just 30 minutes.
Zoellick sees the Greater Bay Area as a huge opportunity, but says the challenge for Hong Kong will be not only the hard infrastructure — railways, bridges, roads — but some of the soft connectivity to move capital, information, and people.
“Policies will have to focus on new cross-border logistics networks and the barriers that impede them, such as new infrastructure to facilitate trade, services, environmental conditions, energy access, standards, rules and a whole series of soft infrastructure issues, such as customs and tax procedures,” he says.
Zoellick says China’s Belt and Road Initiative could be an important part of the new Asian model — if it is correctly developed.
“Frankly, the world is still unclear about the real purpose of Belt and Road. Is it a move for geopolitical dominance across Asia?
“Is it a plan to export overproduction from some of the materials industries in China? Or is it a new corridor for development? How will other countries benefit?”
He says although it is important to focus on the new regional opportunities and obstacles of the Belt and Road Initiative, Asia must stay global in outlook. “For example, even with President Trump’s protectionism, consider the US economy.
“The private sector will continue to be the engine for innovation in the United States — whether it is big data, different business models, or biologics in medicines — Asia must keep linked into that to remain competitive and adaptive.”
A trade leadership vacuum
Zoellick says another important factor shaping trade in Asia is the way President Trump has seen the US abandon its previous role as a key player developing new rules for global trade.
“After some 70 years of a US-led system, I suspect that much of the world has taken the public good aspect for granted,” he says.
“People sometimes reacted against US behaviour and didn’t always agree with it, but because the United States is an innovative economy working at the cutting edge, US officials had to press for new norms and rules to help adapt the international system — in areas such as services, intellectual property rights, transparency, anti-corruption, investment, and even currency manipulation.
“When you consider developments in big data, along with things like personal sensors and innovation in medicines, they can have huge effects on health and are significant business opportunities — but only if the world develops the appropriate legal framework.
“Traditionally, the World Trade Organisation could help do this. But today the WTO is adrift.
“It will not be able to negotiate new rules unless the United States, European Union, China and others can reinvigorate the WTO.”
Zoellick says China might offer an alternative system, but if they do, the world is more likely to end up with a managed trade system.
“The big powers will emphasise national champions, political priorities and sovereign protections over a rule of law framework in which markets will operate relatively freely,” he says.
“That has very large implications for the small and medium-sized economies that have benefited enormously from a rules-based system over past decades.”
The ongoing trade war
Zoellick says that for the near term, he expects to see friction, accusations, and negotiations between China and the US become a fact of life and add to ongoing uncertainty.
But some of the tensions between the two economic giants go beyond Trump and are concerns held across the American political spectrum and among voters.
“A transactional deal would not address the fundamental issues which are causing widespread concern in the United States — including questions about the Belt and Road Initiative and the ‘Made in China 2025’ strategy, which has created anxiety that China intends to dominate advanced technology.
“These concerns are part of the political debate in the US,” he says. “The US cannot decouple from or contain China, but it can work together with China to make sure the rules are followed.”
Zoellick says that although Trump is a protectionist by nature, he will be sensitive to the market.
As he begins to think about his re-election — and particularly if the US economy slows down — he is more likely to do a deal.
“However, if there is a deal, I think we have to recognise that it is more likely to be a truce than a solution,” Zoellick says. “Part of my concern is that I’m not sure President Trump thinks in systemic terms. He thinks in deal-making transactional terms.”
The fresh food e-commerce business is growing in China as Tim McCready reports
Chinese e-commerce giant Alibaba Group launched the sale of fresh produce in 2016 with the introduction of its Hema supermarket chain. These stores have been established as a test bed for what Alibaba calls the “New Retail” concept: the blurring between shopping online and offline.
In order to keep products fresh, Hema’s fresh grocery items are packaged in small quantities — with just enough food portioned out for a small Chinese family.
The supermarket — which doubles as a warehouse and logistics facility — encourages shoppers to buy online using their mobile phones. Alibaba’s smart logistics technology means that as long as the consumer lives within a 3km radius of the store, products will make it into their hands within 30 minutes of ordering.
Last year, Hema supermarkets in Beijing and Shanghai launched a 24-hour delivery service — again with a 30-minute delivery window.
“We found that New Retail doesn’t only merge online with offline, but also connects day with night,” said Hema CEO Hou Yi. The around-the-clock offering includes most items in store, aside from some fresh produce. Cooked meals are available for delivery until 1am.
Hema’s presence in China has expanded rapidly, with the chain now in 80 locations across the country.
Consulting firm iResearch says China’s fresh food e-commerce industry grew by 59.7 per cent in 2017 to 139.1 billion renminbi (NZ$30.13b), noting that fruit is the most popular food item purchased online. Dairy products and vegetables ranked second and third, respectively.
More players are moving into the fresh grocery space. China’s second-largest e-commerce retailer behind Alibaba, JD.com, last year launched its 7Fresh supermarket chain. Like Hema, 7Fresh focuses on fresh food, and promises 30-minute delivery to locations within 3km of a physical store. During its trial period, JD.com said more than 10,000 customers visited the 7Fresh supermarket each day.
JD.com now plans to open 1000 grocery outlets in the next three to five years.
“Our goal is to expand 7Fresh supermarkets into every first and second-tier city and the surrounding areas of those cities,” says Wang Xiaosong, CEO of 7Fresh.
Another fresh produce e-commerce platform, MissFresh, was founded in 2014, and now operates in 20 Chinese cities, specialising in one-hour deliveries of produce.
In September last year, MissFresh completed its Series D fundraise, raising US$450 million (NZ$661 million) from investors that include Goldman Sachs and Tencent Holdings Ltd.
At the time of the raise, founder and CEO Xu Zheng said MissFresh planned to set up 10,000 front-end warehouses in 100 cities around China, which will allow them to provide one-hour deliveries of fresh produce to 100 million families.
The funds from the raise would be used to develop the company’s supply chain, cold chain logistics infrastructure and its smart retail technology.
Food safety, traceability and provenance
Along with a focus on fresh food and fast delivery, supermarkets in China are placing an increased importance on demonstrating food safety and provenance to consumers.
This stems from various food safety incidents in China — most notably the 2008 melamine milk scandal — which have created deep distrust from consumers in food supply chains.
Detail on the origin of products can also help them to stand out as premium products in the minds of the consumer.
Alibaba’s Hema supermarkets encourage customers to scan QR barcodes that accompany every product with their phone. This allows them to receive further information: including how to prepare it, recipe ideas, and its provenance.
Details of the journey of a fresh food item from farm-to-store can include pictures of the distributor’s business licences and food-safety certificates, information on when a particular crop was harvested and the date the item was delivered to the store. For products that need to be kept at a particular temperature — such as meat and fish — the system can provide details on how cold the inside of the delivery truck was during transit.
To further bolster the confidence customers have in its products, Alibaba joined a consortium of four Australian and New Zealand companies last year, to introduce a food traceability system based on blockchain technology.
The consortium — known as the “Food Trust Framework” — includes New Zealand’s dairy giant Fonterra and New Zealand Post, along with Australia’s Blackmores and Australia Post.
A joint statement said of the initiative: “it will use an immutable central ledger to achieve end-to-end supply-chain traceability and transparency throughout the supply chain to enhance consumer confidence and build a trusted environment for cross-border trade.”
The supply chain traceability cross-border trial recently concluded. An Alibaba spokesperson says:
“Following the success of the trial, Alibaba Group will continue to invest in and develop solutions to provide brands and consumers increased confidence and assurance in the supply chain for products sold from New Zealand to Chinese consumers.”
It is estimated that 27 per cent of China’s internet users are based in rural areas, and e-commerce giants are keen to tap into this market, with plans underway for massive development and expansion into inland regions.
Last year, JD.com received approval from China’s Civil Aviation Administration to test a drone delivery network in the northwestern Shaanxi province. The company also announced plans to build 185 drone airports in Southwest China.
JD.com, which has already been operating drones for deliveries since 2016, says it hopes the new drone airports will allow agricultural products from Sichuan to be delivered anywhere in China within 24 hours. “Due to the high costs of logistics, agricultural products sell at a higher price in cities while industrial products sell at higher prices in rural remote areas,” says CEO Liu Qiangdong.
Alibaba has established a “Rural Taobao” initiative, that aims to sell products to regional customers at urban prices, and create efficient supply chains for rural produce.
As part of the project, Alibaba has established a network of 30,000 e-commerce service centres that enable villagers to purchase products online.
General manager of Rural Taobao Bill Wang says: “We want to improve the living conditions of China’s rural regions. To do so, we need to provide high-quality goods, personalised services, smart logistic solutions and prices comparable to that of the cities.”
These moves from e-commerce giants align with the Chinese Government’s National Strategic Plan for Rural Vitalization from 2018 to 2022, which calls for significant progress in rural rejuvenation. The plan has ambitious goals to close the gap between urban and rural areas, eliminate poverty and improve governance in the countryside.