The difference between a dynamic and sclerotic economy is competition. Dynamic economies provide equality of opportunity for everyone, sclerotic ones ensure that only the privileged elites embedded in legacy sectors thrive. When businesses compete for profits, they become more innovative and productive—and the people benefit.
In Australia, the importance of competition is underscored in the Competition and Consumer Act 2010, which exists ‘to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection.’ Moreover, numerous provisions within Australian Consumer Law prohibit anti-competitive business tactics, to ensure that competition can flourish.
Of course, just as new technologies are always being developed and society continually evolves, business tactics rarely stand still. For this reason, Australia’s lawmakers and regulators must be proactive in understanding emerging trends that may threaten competition, to ensure that our laws are appropriate, and effectively enforced.
Accordingly, the House of Representatives Standing Committee on Economics, at the request of the Treasurer, the Hon Josh Frydenberg MP, launched an inquiry in July 2021 into the implications of common ownership and capital concentration in Australia.
There is clearly an urgent need to better understand these related phenomena.
Capital concentration is a term used to describe the extent to which large institutional investors dominate equity markets. There is concern that a high degree of capital concentration can produce an environment in which these investors—sometimes referred to as ‘mega funds’—have significant power to influence the market, potentially to the detriment of both ordinary investors and the market as a whole.
Alongside this concern about capital concentration is the related emerging issue of common ownership. Common ownership refers to a situation in which an investor simultaneously owns shares in competing firms. There is non-trivial evidence that such situations reduce competition and hurt consumer outcomes. This evidence is not unchallenged. It is, however, difficult not to conclude that when funds own shares across major players in a sector, the incentives to invest and compete change to income extraction. That income is typically extracted from consumers.
As Associate Professor Martin Schmalz so eloquently put it, if there are only two bakeries in town, competition authorities would not allow one to buy the other as that would create a monopolistic duopoly. If, however, an investor bought a 50 per cent stake in both, there would not be prohibitions on this, and now the shareholder can use their influence to direct management strategy away from investments in product improvement or market share acquisition. The outcomes are the same, but one approach is highly likely to be unlawful and the other beyond the scope of current competition laws.
In Australia there is already a significant proportion of value in our equity markets controlled by an increasingly small number of large institutional investors. This trend has been growing steadily over time, and there is evidence to suggest that it will continue on an upwards trajectory, given the increasing consolidation in the superannuation sector, the increasing rate of compulsory contributions, and the continuing rise in popularity of low-cost index funds. We have already observed significant assets being delisted from the Australian Stock Exchange, such as the Sydney Airport.
The prospect that investors might seek to stifle competition is clearly concerning. Any situation in which a small number of large investors can dominate financial markets while also owning competing businesses presents a serious risk to healthy competition, and indeed may be a trigger for higher prices, lower quality goods and services, and lower relative wages.
To date, though, there is a lack of evidence as to whether the concerns associated with capital concentration and common ownership can be validated. As part of this inquiry, the committee heard evidence from a wide range of stakeholders, including academics, financial sector regulators, banks, index and superannuation funds, and relevant peak bodies.
Overall this evidence is contested. It is, however, clear to the committee that the rationale underlying the theory is compelling, made more so by the fact that its outcomes are observed but its process is difficult to monitor. The phenomena should be carefully scrutinised over the coming years.
Accordingly, the committee has considered mechanisms that would allow for the collection of comprehensive, accurate and easily accessible data to measure and track these phenomena.
The committee has also sought to better understand research that has been undertaken into so-called transmission mechanisms through which common owners might exert their influence, with a particular focus placed on voting practices, investors’ engagement with the management of companies, and management remuneration.
As a result, the committee’s recommendations for this inquiry are focused on improving transparency about the holdings and behaviours of institutional investors, and on empowering our financial regulators to monitor capital concentration and common ownership closely and to be able to respond appropriately should competition be affected.
Ultimately, it is critical that our regulators be proactive in understanding the risks associated with capital concentration and common ownership now, so that we will not have to confront a larger issue in the future.
Mr Jason Falinski MP