The House of Representatives Standing Committee on Economics is currently holding an inquiry into the implications of common ownership and capital concentration in Australia.
In this article I look at whether there is a problem and what law reform proposals are floating out there to deal with the purported problem. Finally, I suggest where things may head in Australia.
What is common ownership and capital concentration?
Common ownership is simply the situation where rival firms within the same industry have the same owners. For instance, an investment fund may have stakes in several retail banks. In the Australian context, a paper published by the Deputy Chair of the committee Dr Andrew Leigh MP has identified 49 industries that have common ownership, including banking, health insurance, supermarkets and fuel retailing.
Capital concentration is where the ownership of capital becomes less diversified, and in the hands of a smaller and smaller group of big funds. A recent Rainmaker report predicts that by 2025, Australia’s 10 biggest superannuation funds will hold 80 per cent of the superannuation market. There has also been large growth in index funds over the past few years, meaning the big retail funds will hold a greater proportion of the ASX.
What is the problem?
Put together, a smaller number of big funds holding a greater proportion of capital on the ASX and having increasingly large stakes across competitors in several industries is creating a concern across both sides of politics that this situation may pose risks to competition in the Australian economy.
Liberal MPs appear concerned that the consolidation of the superannuation industry could strengthen the hand of activist investors and may not always be in the best interests of beneficiaries. Labor MPs appear concerned that the growth of index funds mean greater power for investors to encourage less competition in major Australian industries, ultimately leading to sub-optimal economic outcomes for consumers through higher prices and lower output.
There is academic literature, particularly from the United States, that suggests in industries such as banking and airlines where there is greater common ownership, there is a correlation with higher prices and lower output. They suggest that companies with common owners are more likely to engage less competitively, acting not in the interests of maximising the profit of their own company, but to maximise the value of the total portfolio of their common owners. To compete aggressively may be to hurt a rival company that is also owned by their common owner.
Importantly, the theory suggests that while these anticompetitive outcomes may occur with the direct encouragement of common owners, they don’t have to. A ‘lazy investor’ may be happy to refrain from encouraging competition, and a company manager wanting to live the quiet life may be happy to accept their market share and prevent upsetting their institutional shareholders.
However, the common ownership theory literature is highly contested and not well supported by tangible evidence. There is a strong argument that a causal link between common ownership and anti-competitive outcomes has not been proven. For one, in the Australian context common owners usually have minority stakes; 5 per cent at most in rival firms.
Were a company theoretically acting less competitively in the interests of minority common owners, other institutional investors would see there is unrealised value and buy larger stakes to encourage more aggressive competition. Even with common ownership, there remain many incentives toward competition such as stock remuneration, bonuses, competition law and directors’ duties.
The FSC’s perspective is that it is not in the interests of highly diversified investment funds to encourage lower levels of competition. It is not consistent with an investment fund’s legal obligations. And a more competitive economy leads to greater economic growth, and greater returns for beneficiaries in the long run.
What are the law reform solutions being proposed?
Some common ownership literature has suggested the following reforms to prevent the anticompetitive harms that may arise from common ownership and capital concentration:
- Laws should prohibit investors from having stakes in more than one rival firm. If an institutional investor wanted to invest in the retail banking industry, they would have to choose one retail bank and would be prohibited from holding a stake in a rival retail bank.
- Investors can have holdings across rival firms, but this should be limited to 1 per cent stakes. In this scenario, an investor would only be allowed to have 1 per cent in Bank A and 1 per cent in Bank B. If they wanted to increase their stake in Bank A, they would have to divest completely from Bank B.
- If investors are to be common owners with no holdings limits set, they should be prohibited from engaging with company management or exercising their votes.
These proposals are quite radical. They would prevent institutional investors from engaging in diversification, not to mention making the business of investment management completely unworkable. Proposals to prevent institutional investors from engaging in stewardship activities would not only be a radical departure from the long-accepted rights that attach to shareholding; they would remove effective accountability for company directors. ASIC Regulatory Guide 128 explicitly recognises the value of effective investor engagement in enhancing corporate governance and long-term corporate performance.
These proposals have been considered in the United States and Europe and have not been adopted. The FSC is strongly advocating that it would be disruptive to investment markets and harmful to consumers if these options were considered in Australia.
Sections 45 and 46 of the Competition and Consumer Act 2010 are adequate to deal with the issues claimed to arise from common ownership. If common ownership had the effect or likely effect of substantially lessening competition in a market, the ACCC could act. For listed companies with common owners, directors have duties under section 181(1) of the Corporations Act 2001 to act in the best interests of the company. This must be in the best interests of the company as a whole, not in the sole interests of minority shareholders who may be common owners.
Through the course of the hearings, committee members have floated the following policies:
- That the proxy voting rights exercised by trustees should be 'devolved' to fund members to prevent the concentration of power that arises from capital concentration,
- The creation of a beneficial ownership register to better understand the true extent of common ownership in Australia, and
- The reduction of the reporting threshold for substantial ownership from 5 per cent to 1 per cent.
While the committee will not issue a report for some time yet, the FSC is engaging with these proposals seriously. While the proposal to devolve voting rights to everyday Australians would have appeal to those who are uncomfortable with the increasing power of large funds, there are concerns about whether superannuation members could engage with the thousands of resolutions from the listed companies that they invest in.
Where are things heading?
In looking into this issue, are policymakers tilting at windmills? When it comes to the common ownership theory, many think there isn’t much to it.
However, the ACCC has expressed concerns about a more concentrated superannuation industry exercising greater market power. While merely having market power is not unlawful, the concern is that this greater concentration of capital could increasingly have the effect of lessening competition.
As the superannuation industry consolidates and as more Australians engage in retail investing, policymakers from both sides of politics and the ACCC will be looking closely at how big funds are using their market power, a power that ultimately comes from being entrusted to steward the savings of millions of Australians.
The FSC’s submission to the House of Representatives Standing Committee on Economics inquiry into the implications of common ownership and capital concentration in Australia can be found on the committee website here.
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