Roy Davidson, 30 October 2018

Political and regulatory uncertainty in Australia has recently stepped-up making the job of investing in Australia that bit more difficult. In addition, the next federal election will most likely take place in May 2019 and the possible election of the Australian Labor Party (ALP) brings its own sector and economy-wide risks.

There are certainly a number of quality investment opportunities across the ditch with a number of companies having large global operations. However, investors may need to be a bit more selective given these risks. We will look at a handful of the key areas of political/regulatory uncertainty to consider.

Energy policy - what next?

The energy sector has been plagued by political mismanagement for some time. This has seen wholesale electricity prices rise to record levels as gas availability has reduced and baseload (coal) generation has exited the market.

Australian wholesale electricity prices have increased markedly

electric prices aus

The National Energy Guarantee (NEG) was the Australian Government’s proposal to increase supply reliability, lower prices and meet Australia’s emissions obligations. The NEG received widespread support and was expected to bring much needed certainty to the energy sector.

However, the policy was dropped and there is now greater scope for more aggressive measures. Ultimately, a rehashed NEG is likely to re-emerge, but sector risks have certainly increased.

Franking credits – ALP proposes eliminating franking credit cash refunds

The Australian franking credit system is very similar to New Zealand’s imputation credit regime. Companies distribute franking credits which reduces the amount of income tax an individual investor pays on dividends, thereby reducing double taxation.

One difference, however, is that Australia has a system of franking credit cash refunds. This enables investors to receive a cash refund for any franking credits that are unable to be utilised. The ALP has proposed removing this for a majority of shareholders.

Investors heavily favour companies that pay a ‘fully franked’ dividend, including the major banks, Telstra, the miners, and the supermarkets. The removal of cash refunds would see a drop in the appeal of these shares, potentially moving funds away from these companies and seeing prices drop.

Royal Commission inquiry into financial services misconduct

The financial services Royal Commission has unearthed a myriad of issues impacting the banks, insurers and wealth managers. Key areas include mortgage lending standards, issues of malpractice, and issues associated with vertical integration and consequent conflicts of interest.

The Royal Commission recently released its interim report, providing a steer as to potential implications. While the report discusses multiple areas of misconduct, it also points the finger at the sector’s regulators which it states haven’t been tough enough in their enforcement of the laws.

Uncertainty in relation to the inquiry will continue to dent sentiment in the sector, while the operating environment is becoming challenged.

Royal Commission inquiry into aged care

The Australian Government announced another Royal Commission, this time into the aged care sector. This follows several high profile cases of malpractice in some aged care facilities. Allegations are largely centred on quality of care not meeting acceptable standards.

While there is little detail on scope or implications, we expect the inquiry will review care standards, sector funding, and staffing levels, among other issues. Revelations on the scale of the financial services Royal Commission inquiry are unlikely, however, investors are justifiably cautious. Sentiment and consequently share prices in the sector will remain under pressure for the time being.

The other question is; will another sector become the subject of a Royal Commission inquiry? With an election around the corner and the new leadership still trailing in the polls, it is possible for further inquiries to be called given the fallout from the financial services inquiry and the political points that can be scored.