The Australian Securities and Investments Commission issued its interim report from the ASX (ASX: ASX) inquiry. Shares fell more than 5% on the day of the report and continued their slide the next day.

Why it matters: The report follows years of increasing regulatory scrutiny and suggests that regulatory scrutiny and associated costs will remain elevated for years to come, which is above our prior forecasts.

  • The report asserts undue prioritization of shareholder returns at the expense of technology investment. As we wrote in our Feb. 13, 2025 note, we preferred seeing the exchange continue high investment levels to stave off regulatory ire.
  • The exchange now needs to hold an additional $150 million in reserves until ASIC is satisfied that certain improvement milestones have been met. As a result, the near-term dividend policy is cut to the lower end of the 75%-85% range, down from 80%-90%.

The bottom line: We lower our fair value estimate for wide-moat ASX by 4% to $70 per share based on expectations for continued costs related to the improvement program. Shares screen as materially undervalued.

  • Our assessment is that technology spending has been elevated in recent years. The exchange is under stiff media and regulatory scrutiny, which dictates that near-term spending will continue to be high.
  • But over the longer term, as media and regulatory scrutiny subsides, we expect costs to come down. We expect operating margins to start expanding again in fiscal 2029 and return to the high-50s at the end of our explicit forecast period in fiscal 2035, similar to fiscal 2025.

Big picture: The primary cause of the scrutiny is the failed replacement project for the Clearing House Electronic Subregister System, in our view.

  • Most other errors, such as recent publishing errors or other technical glitches, seem to be the result of human error rather than underinvestment or glitches in line with what we think are reasonable operating expectations for exchanges.

Regulatory scrutiny of ASX dictates elevated costs and lower dividends

We expect Australian Securities Exchange’s near- and medium-term strategic focus to be on protecting its economic moat in cash equity clearing and settlement. ASX has long been protected from competition through various exclusive licences to clearing and settlement, which we consider a source of its economic moat, based on intangibles. However, over the past decade, ASX has faced increasing calls from the federal government, regulators, and industry bodies for more competition.

In response to these calls, ASX attempted to deliver a world-leading new clearing system, based on blockchain. However, after several years of delays and cost overruns, this project has been binned, which has renewed discussion on opening up the clearing and settlement market to more competition. ASX, we believe, will therefore focus on trying to demonstrate to the federal government, regulators, and industry bodies that it is capable of maintaining smooth operations of Australia’s financial infrastructure, including by increasing spending on its various systems.

Regardless of the potential regulatory outcome, cash equity clearing and settlement make up only around 15% of ASX’s revenue. Moreover, we believe that even if cash equity clearing and settlement would be opened up to competition that ASX’s business would remain well protected due to network effects inherent in ASX’s clearing business. We therefore do not expect significant changes to ASX’s cash equity clearing and settlement market share or margins in the foreseeable future.

Bulls say

  • ASX is a vertically integrated exchange with a wide economic moat based on network effects and intangibles.
  • ASX benefits from exposure to Australia’s outsize natural resources sector and the energy transition will continue to fuel demand for ASX’s listing services.
  • Volatility will increase demand for ASX’s trading and clearing services, especially for companies in the highly volatile materials and energy sectors, which make up around half of total listings.

Bears say

  • ASX has failed to adequately secure its economic moat based on regulation and now risks increased competition and costs.
  • ASX has not yet presented a credible plan to replace its ageing clearing system.
  • Uncertainty in financial markets may negatively affect ASX’s listings business, which is disproportionately large compared with peer exchanges.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.