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November 2012

Investing in an election year Markets in the political silly season

www.politicalmonitor.com.au


CONTENTS

About Political Monitor

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Executive summary

5

Politics & markets

8

Political outlook | Nov 2012 – Nov 2014

11

Political risk & Australian equities § § §

Resources Financials Telecommunications

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Conclusion

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Disclaimers, copyright & trademarks

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Acknowledgements

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

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.

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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 “ … a picture of heightened uncertainty for key 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.

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

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.

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

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.

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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 “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.”

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

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

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

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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 “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.”

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:

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

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.

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

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.

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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 “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.”

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

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

$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

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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 “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.”

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.

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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 “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 …”

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.

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

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

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

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

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Western Australia, which has some of the world’s largest uranium reserves. Accordingly, investors exposed to uranium “ … 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.”

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

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

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

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

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.

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

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.

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

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.

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DISCLAIMER, COPYRIGHT & TRADEMARKS Political Monitor is a business name registered by DCK Holdings Pty Ltd ATF DCK Family Trust (“Seller”). Disclaimer Information in this document is subject to change without notice and does not represent a commitment on the part of Seller. Seller does not warrant the accuracy, completeness or timeliness of any of the data and/or programs (“Information”) available within the report. The Information is provided “as is” without warranty of any kind, express or implied, including, but not limited to, implied warranties of merchantability, fitness for a particular purpose, title or non-infringement. In no event will Seller or its affiliates be liable to any party for any direct, indirect, special, consequential or other damages for any use of or reliance upon the Information found within the report, or on any other reference documentation, including, without limitation, lost profits, business interruption, loss of programs or other data, even if Seller is expressly advised of the possibility of such damages. The disclaimer is in addition to the specific terms and conditions that apply to the products or services offered by Seller. Copyright Copyright © DCK Holdings Pty Ltd ATF DCK Family Trust 2012. This document is copyright and contains confidential information that is the property of Seller. Except for the purposes of executing or applying this report, no part of this document may be copied, stored in a retrieval system or divulged to any other party without written permission. Such rights are reserved in all media. Intellectual property rights associated with the methodology applied in arriving at this document, including templates and models contained there in, reside with DCK Holdings Pty Ltd ATF DCK Family Trust, excepting client information it contains that is demonstrably proprietary to the client or covered by an agreement or contract defining it as such. No part of this report may be reproduced, transmitted, stored in a retrieval system, or translated into any language in any form by any means, without the written permission of DCK Holdings Pty. Ltd ATF DCK Family Trust. © DCK Holdings Pty. Ltd ATF DCK Family Trust. 2012 All Rights Reserved ACN 137 934 386 ABN 60 509 131 934 Trademarks The Political Monitor logo and products referenced in the report are trademarks, service marks, registered trademarks, copyrights or other intellectual property of DCK Holdings Pty Ltd or its affiliates.

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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.

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Investing in an election year  

The next twelve months present as a time of heightened political risk for investors in the Australian market. Ongoing leadership speculation...

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