Heidi Norman

Kia ora and welcome to the next episode in the financial market authorities, occasional Conversation series, podcast. Today I'm joined by our chief economist Stuart Johnson, and we're going to be talking about the latest research report around market cleanliness. Stuart, can you tell us about market cleanliness?

Stuart Johnson

Certainly, Heidi, thanks very much for having me. So market cleanliness is a concept that relates to the stock market. What we're trying to do is think about whether there's any market manipulation or insider trading happening on the stock market. So we would think of a clean market as a market where we don't see any or perhaps. Only a very small amount of evidence of market manipulation, so this report really looks at how clean the New Zealand stock market has been over the last 20. Years and hiding. Most importantly, I'm really pleased to be able to say that we see the level of market cleanliness increasing over the last 20 years. Or put differently, we would say that the evidence of market manipulation has been falling over the last 20 years. And Heidi, that's really great. News for investors and think about it. In New Zealand, nearly everybody's got a Kiwi saver or everybody of working age and most Kiwi savers have at least some money invested in the stock market. And secondly, it's great news for firms that use the stock market to raise capital because all of those market participants are really interested in a clean market where there's very low levels of market manipulation.

Heidi Norman

Well, that sounds like really great news, Stuart. But how do you even measure something like that?

Stuart Johnson

Heidi, it's a little bit complicated and it's a little bit mathematical, but if you let me explain it, I'm I'm sure that it will be obvious and all of our listeners will understand. I want you to start by imagining that there's an individual firm that's listed on the NZX. OK, let's pretend that there's a car manufacturer in Auckland. Let's just call them Jane's cars, OK? And let's say that their share, their share price normally trades around $100. Some days it might be as low as 98 dollars. Other times it might be up there at 100 and two 103. But over the last year it's broadly been around $100. So. Jane's Automotive is going to release their annual report and the share price carries on trading around $100 in the lead up to the annual report. But then, when the annual report is published, it turns out that Jane's automotive has had a great year. They've sold lots more cars than they expected. And they're going to open a new manufacturing plant. Now. Unsurprisingly, this is great news. And their share price goes from around $100 all the way up to 120. Now, Heidi, that's sort of as we would expect the market to operate, we've got a firm that's tracking along reasonably well. They release some good news and their share price goes up. So I want to contrast that with a slightly different situation. Let's stick with the same car manufacturer, James Cars. Their share price has been trading for around the last year, again at $100. And let's say next week they're going to release their annual report. Right now, the shares trading at $100. But a couple of days before it starts trending up and it starts trading at $105.00 and then 107 dollars, $110 and then the day the annual report is announced is released. It jumps all the way up to $120.00. Now, Heidi, what do you think might be happening in this situation?

Heidi Norman

It sounds like someone's got some information and they've decided that they're going to buy some shares in Jane's cars.

Stuart Johnson

Absolutely. And so we would describe that as a situation where the information is leaking out ahead of the announcement. Sometimes you'll hear the term information leakage and that's really in reference to the fact that it seems from the share price that somebody. Or maybe even a collection of people already know the news that James Cars is going to release in a couple of days. And they're trading on that information in the stock market now because not everybody has that information. We would think of that as being evidence of some form of market manipulation. And we might say that that's evidence that there's some form of uncleanliness on the market. So we've got these two situations in situation. One, no information leaked and in the second situation, it seems there was some information leakage leading up to the announcement. And here comes the maths, Heidi. Basically what we do is we look at all of the announcements in a particular year and we categorise them as either those that look like there's no information leakage and those that look like there is and we take a percentage of the ones that look like there was a little bit of information. Leakage over all of the announcements and that gives us a statistic, or really a percentage for the level of potentially unclean trades. In an individual year. And what we can see in the report is that that percentage is falling overtime and that's why I said that it was good news because it seems like the market is getting cleaner.

Heidi Norman

Great. So Stuart, what should? Investors and and New Zealand firms take from this research.

Stuart Johnson

So investors and New Zealand firms looking to raise capital on the NZX. They should be pleased. It's good news that we see the level of market cleanliness increasing over the last 20 years. It should give investors confidence that there isn't wide scale market manipulation on the NZX and that should give people comfort that their their money is invested in a market that's clean. Conversely, highly the same thing goes for companies that are looking to raise capital. You know, we don't talk about. Initial public offerings or secondary public offerings so much. But when firms are looking to raise capital going to the NZX and listing their firm is a really great way of doing that. As long as the market's clean and this report absolutely evidences that the market is clean and that would be a a viable option for firms, there's a lot that goes into that decision, Heidi. But it's really important that those firms have confidence that the market is.

Heidi Norman

Clean. That sounds really promising, Stuart. Is that the only metric in the report?

Stuart Johnson

It turns out, Heidi, there's actually 2 metrics in the report. There's the metric that I have just explained that looks at the share price and it looks at movements in the share price ahead of the announcement. There's a second metric in the report that looks at the volume. So the amount of shares traded, it's a little bit more techie and it's not really worth going into. But for those people who are looking to. Read the report. Looking at both the price and the volume of shares traded really helps us to understand how clean the market is.

Heidi Norman

Thanks Stuart for sharing that with us. OK. And thank you very much for joining us today on our latest occasional Conversation Series podcast. If you'd like to read the report, you'll find it on our website at www.fma.govt.nz. Thank you very much.