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| The government has introduced legislation that supports the deveopment of Austria’s stock market. |
AUSTRIA’S STOCK MARKET was a sleepy backwater for most of the past decade but sprang to life last summer. The ATX index has doubled over the past 18 months, making Austria the best-performing market in western Europe. As the Wiener Börse breaks all-time highs on nearly a monthly basis, investors are streaming into Vienna. Austria has arguably become the first western European country to benefit directly from the enlargement of the European Union in May 2004. At the end of November the ATX index broke through the psychologically important 2,000 mark for the first time after spending most of the past 10 years hovering around 1,000. Austria shares more borders with the central European countries than any other EU country and investors have latched on to Austrian industry as an obvious eastern Europe play but one that backs tried and tested western European names.
Untroubled by the bubble
“There was a boom in the 1980s and then the Austrian market went to sleep for the next decade,” says Harald Riedler, head of custody at Raiffeisen, one of Austria’s three biggest banks. “The dot-com bubble completely passed Austria by, so when it burst and investors were looking around for conservative companies that were not overvalued they turned to the ATX as a safe haven.”
The only new economy company listed on the Austrian exchange at the end of the 1990s was telecoms firm Cybertron. Predictably the stock soared during the hype and crashed in 2000. The company went bankrupt two years later.
The stock market’s 35% gain in 2003 and just under 70% rise since the start of last year has been driven by Austria’s traditional mix of old-economy companies: including banking, oil, construction materials. Of these, 77% have invested in central and eastern Europe, according to Erste Bank research.
The creation of the Iron Curtain at the end of World War II hurt Austria’s economy, turning it from the hub of the once powerful Austrian-Hungarian empire into a small mountainous country of
eight million people on the very edge of Europe.
For most of the post-war period the financial market has ticked over, simply lending money to Austrian companies working within the limits of a small market. Credits still account for three-quarters of the financial system, while more recently the government has been making more active use of the domestic capital market to raise money; government debentures account for over half of the healthy bond market. However, with the door to the east open again, companies have been turning to the domestic market for capital.
Bank and corporate bond issues have been growing strongly in the past two years. Austria’s bond market is still bigger than its equity market. However, equity is the fastest-growing part of the financial system: bond market capitalization has grown from e13 billion in 1990 to e106 billion by December 2003 whereas the capitalization of the equity market has increased from e29 billion in 2001 to e60 billion in just over three years.
There is still a long way to go. Equity market capitalization remains small both in absolute and relative terms. It has grown from 4% of GDP two years ago to about 25% now, but it is still one of the smallest markets in Europe, well behind Germany’s 31.2%, the US’s 86% or the UK’s 111%.
The general economic recovery in eastern Europe catalyzed the ATX’s recent gains, but the strength of the growth has been supported by the combined effort of the government, the Wiener Börse and listed companies to give the equity market a makeover.
The Wiener Börse’s programme to boost market capitalization and attract foreign investors was launched in 2000 and is beginning to bear fruit. A prime market has been set up for the blue chips, where companies have to meet high standards of transparency, produce quarterly reports to American GAAP or international accounting standards and maintain a free float of at least 25%.
“All this was designed to show that the value of our companies was real,” says Wiener Börse chairman Stefan Zapotocky. “For years Austrian companies were undervalued, with P/E ratios below 10. The opening of eastern Europe has kickstarted a re-rating. For the first time since World War II, Austria has access to this market operating under an open infrastructure.”
A few years ago the market’s membership comprised solely local banks, but over the past two years international banks have been joining and now account for 40% of market members. Foreign
portfolio investment has climbed from next to nothing to about 45% of capitalization now.
Zapotocky argues that the recent gains are no flash in the pan as Austria’s energy and telecoms sector are both largely in state hands and slated for privatization. Moreover, although there are fewer than 10 IPOs each year, he is expecting issuance to pick up.
“We will see more private companies come to market as they already have a desperate need for investment capital,” he says. “In the past companies have been able to raise all the financial resources they need from their own capital or through credits, but now the growth is picking up this is no longer enough.”
Running parallel to the exchange’s efforts to attract more investors, the government has introduced legislation that directly and indirectly supports the development of the stock market. The first round of reforms were initiated as part of Austria’s preparations for EU membership in 1990 and more recently by changes to meet the EU’s financial directives aimed at creating a European-wide capital market. But the financial reforms accelerated in 2001 when the current conservative government took over from the socialists.
“The government is committed to keeping the securities infrastructure up to scratch. The market may be small, but it is seen as vital to the economy and the government makes active use of the exchange,” says Georg Zinner, chairman of the Österreichische Kontrollbank (ÖKB), which handles clearing and settlement for the market.
Excising bureaucracy
Now Austria is once again squarely in the middle of Europe, the government has targeted development of the capital markets as crucial for the economy’s development and has taken the knife to an overly bureaucratic system.
“The financial markets regulation built up over decades,” says Raiffeisen’s Riedler. “You start with a rule and then as new situations come up amendments are bolted on. Slowly the regulations become complicated and unwieldy until you come to a point where it is easier to draw a line and start again. That is what is going on now.”
In April 2002 a single super-regulator was created, the Financial Market Authority (FMA), to oversee everything from banks to the stock market, as well as advising the government on developing legislation. The Wiener Börse and government joined forces to promote a corporate governance code. And market structures were reformed to bring them in line with western Europe. For example a central counterparty will be created. The IMF recently described Austria’s regulatory system as one of the best in Europe.
“The creation of the central counterparty won’t make much difference to the operation of the market. The difference is that before we had to give these long explanations to foreign investors about how things worked here and now we can just say ‘there is a CCP like everywhere else’,” says Zinner.
Austrian companies have also risen to the challenge, preparing the ground so that they can tap the stock market for capital to fuel their rapid expansion.
“Austrians are hard working, but they are not very good at selling themselves,” says Raiffeisen’s Riedler. “Our companies have realized in the last few years that it is important to develop investor relations. Five years ago companies didn’t even have investor relations officers, but now they realize if they are going to be successful on the stock exchange they need this specialized marketing.”
Austria is blessed with a healthy economy compared with most of its fellow EU members to the west and the government has built on the momentum to tackle some thorny financial reforms that will provide general support to the market.
Austria’s public pension scheme was the most generous in Europe according to the OECD, and not sustainable. Austria suffers from the same demographic and funding problems as Germany, but unlike in Germany the government has introduced incentives and tax breaks that have persuaded Austrians to buy private pension funds to supplement the state system in their old age. Last year the private pension funds were the fastest-growing financial product.
A sizeable chunk of these new resources will be ploughed back into the stock market, thanks to restrictions imposed by the government to support the domestic market. Pension funds are obliged to invest 40% of their funds in “countries in which the stock market capitalization as a proportion of GDP doesn’t exceed 30%”. As only Austria, Hungary and Poland are below this limit (and both Hungary and Poland are about to go over it) pension funds will become big investors in the Wiener Börse.
“The rule is part of the government’s efforts to support the local market but pension funds still don’t play a big role in the trading and account for less than 1% of the daily trading volumes of between e30 billion and e40 billion,” says Zapotocky.
Funds need time to build up their capital as although Austrians are traditionally big savers, they keep most of their money in savings accounts with their Hausbank and most consumers are still not used to the idea of funds.
A savings account culture
Savings rates remain high, but the proportion of Austrians owning stocks has been creeping up only slowly. A study by market research firm FESSEL – GfK found that 13.4% of Austrian population owned securities (including things like mortgages) in 1999, which has grown to 17% in 2003, and the percentage of Austrians owning shares was 6.5% in 1999 but increased to 7% in 2003.
“The Austrians are traditionally savers, but not in a structured way. They keep most of their money in savings books (little books banks hand out with accounts that record the amount on account) and most people still rely on the social contract with the government to take care of them in their old age,” says Raiffeisen’s Riedler.
Still, Austria’s 23 asset management companies got off to a flying start after the new regulations came into force last year.
They sold a total of 281,138 policies worth e238.5 million, making private pensions the most popular retail financial product.
Pension reform was not popular, but the state stuck to its guns, facing down strikes last spring, as the government reneged on the traditional social contract – an implicit promise to take care of them in their old age. The unrest began a debate over pensions and the unions came to realize that the old PAYE system would fail.
“History shows that it takes one generation to get burnt before the next generation gets terrified,” says David Penstone, global head of sales at Bank Austria Creditanstalt. “There is not a lot of domestic demand [for stocks] but this is not an undercapitalized market. There is a political will to push the ATX so we need to mobilize domestic resources to grow the Austrian companies.”
Austria’s economy is in pretty good shape, reducing the pain of change. The budget deficit is a modest 1.3% of GDP, total debt to GDP a manageable 60% and inflation is 2.1%, allowing the government to follow the eastern European example of slashing taxes that so appeals to investors. Corporate profit tax has already been cut from 34% to 25% and a main round of fiscal reforms will be implemented this year.
“The first part of a major tax reform was put in place in 2004 and the biggest changes will be implemented in 2005 with more cuts to income tax among other things,” says Marcus Scheiblecker, an economist with the Austrian Institute for Economic Research, a government-backed think-tank. “It is a message to investors that we still want investment to come so we can compete with the central European countries.”
The fruits of an early advance
Bankers in Austria concede that the ATX won’t be able to keep up 2004’s pace of growth but believe the continuing reintegration with the CEE economies will continue to support the index. Some of the foreign capital arriving on the ATX was fleeing the post-dot-com turmoil, but now the pump is primed Austria’s stock market could bet at the start of long-term growth.
“Austria was quick into eastern Europe when it opened up more than a decade ago, when it was still risky. In the second half of the 1990s these investments became solid businesses and now we are reaping the fruit,” says ÖKB’s Zinner.
The fall of the Berlin Wall opened a huge new market for Austria and this was enhanced by May’s EU expansion. While the Germany economy, Austria’s main trading partner, remains stagnant, the Austrian economy is expected to have grown by 1.9% in 2004 and should reach 2.5% in 2005. The change is written all over Austria’s trade statistics: in 2003 the 15 western European EU countries took two-thirds of Austria’s exports while central and eastern Europe accounted for less than a fifth. Trade with the CEE countries has increased four-fold since 1989, with Hungary, the Czech Republic and Slovenia already Austria’s most important trade partners while exports to the Balkans and Romania are the fastest growing.
A lot of this trade is actually Austrian CEE subsidiaries ordering goods from home and Austrian direct investment in its neighbours is continuing apace. Between 1999 and 2002, Austrian investment in the CEE quadrupled to e4.2 billion, before the European-wide slowdown took the edge off inflows in 2003. However, it is expected to pick up again on the back of the modest economic upswing.
After a difficult transition two-thirds of these Austrian companies are now making a profit. In some cases the CEE subsidiaries have overtaken the home market as the main profit centres.
“The benefits of EU expansion are already here,” says Scheiblecker of the Austrian Institute for Economic Research. “Duties were already lowered before the May 1 accession of the new EU members. Much of the benefits have been consumed by both sides but we are not in bad shape and 2.5% growth shows we are coming out of a downturn in the cycle after five or six years of soggy growth.”
Despite the ATX’s impressive performance, the government reforms and the companies’ eager seduction of foreign investors, Austria will always be a small market. The obvious solution is for all the exchanges in CEE and the Balkans to join forces; none of the countries in the region (bar Poland) has a population of more than 10 million, but together they become a dynamic 80 million-strong group – the same size as Germany, Europe’s biggest economy.
Integration will be difficult and while Vienna has thrown itself into building up the domestic capital market, governments of other countries such as the Czech Republic are less interested in their stock markets.
Still, the first move towards a regionally integrated market has already been taken. Last year, Hypovereinsbank (HVB), which owns Bank Austria Creditanstalt, headed a consortium of market participants to take control of the Budapest Stock Exchange (BSE). Penstone says while HVB would welcome a merger between the ATX and the BSE it is up to the Wiener Börse to make the first move.
“Poland, Hungary and Austria’s markets are pitted against Frankfurt, New York and London’s markets,” he says. “The key for growth on these regional markets is to concentrate on the local companies if we are to build up a strong bourse. The regional markets need to work together, but we will see where it takes us.”
Zapotocky says the Wiener Börse’s long-term goal is regional integration, which fits with the general EU trend to build closer cooperation among stock exchanges, but admits it will take time. Beyond the practical problems and cost of integrating half a dozen different systems is the question of national pride and different governments’ level of commitment to developing domestic capital markets.
“We need to get all the minor bourses together into a group that is active in central Europe,” says Zapotocky. “The first step has been taken with the BSE and we need to convince the other exchanges to create a common central European market with open cross-border trading. Taken together, Poland, Hungary, Slovakia, Slovenia, Czech Republic and Austria is a very large part of Europe. It won’t be so hard, as the leading 10 to 15 market players in the region are already everywhere with all the systems and have at least a 80% market share.”
