Legislation to transform capital markets, boost investor confidence

In this article, senior associate Stephen Layburn provides a useful reminder of pending legislative developments arising from the Review of Financial Products and Providers against the backdrop of the public war of words that has broken out between Minister of Commerce Lianne Dalziel and media commentator Brian Gaynor about the Capital Market Development Taskforce.

In an open letter to the Minister of Commerce¹, Brian Gaynor is scathing of the newly established taskforce designed to look at the current state of our capital markets, the international context, future risks and opportunities, and changes needed to deliver the best possible financial system for New Zealand.

Gaynor's argument

In his letter to the Minister, Gaynor gives his view of many of the problems affecting capital markets activity in the period since 1987.

He argues the new taskforce is stacked with representatives of the "sell-side" of the market and should have contained a reasonable number of representatives of small investors from the market's "buy-side". He says successful markets depend on having sellers and buyers who have "total confidence in the integrity and reliability of the process", and investors currently have little confidence in our capital markets because of past indiscretions and a lack of regulatory protection.

Gaynor's view of the problems include well-known statistics on New Zealand investment which provide a sad reflection of the level of depth and spread of capital markets activity in this country. Over the years, Gaynor's views have remained consistent and he provides a valuable contribution to the national dialogue on the state and development of our capital markets, largely from a "buy-side" perspective.

Russell Committee

One bone of contention in Gaynor's argument is his escalation of the significance of the output from the Ministerial Committee of Inquiry into the Sharemarket chaired by former Reserve Bank Governor Sir Spencer Russell (Russell Committee) and the reasons why the Russell Committee's recommendations were not implemented. Assembled in 1988, after the events of 1987, the Russell Committee reported its findings in early 1989. Gaynor reports that none of its recommendations were implemented because of what he describes as "capture" by a combined force of Treasury "dries" and interests associated with the Business Roundtable.

The Russell Committee's recommendations were described at the time as falling into three loose groupings: the first two relating to improving the efficiency of trading and the flow of market information and the third relating to market supervision and enforcement. Arguably, the first two areas had already been addressed or were in the process of being addressed by the time the Committee released its report. In addition, there have been a number of incremental changes to the NZX Listing Rules and the Securities Markets Act 1988 which have bolstered support in this area. It is also possible to point to the changes to the Securities Markets Act which came fully into force on 29 February 2008, particularly those relating to insider trading and market manipulation, as providing additional legislative teeth.

The third area was that of market supervision where the Russell Committee's recommendations were described as prescribing a self-regulatory structure within a statutory framework. Again, it is arguable that this model had already been established and, in the case of the co-regulatory model now being pursued with success by NZX and the Securities Commission, can be seen to have worked well.

Gaynor does make a observation about the knock-on impact of regulatory activity. In referring to recent events he notes that capital has simply moved to the less well-regulated parts of the economy such as the finance company sector and a seriously over-heated property sector. The blame for this he lays at the feet of the financial advisory profession.

Minister's response

In part, the Commerce Minister's response seeks to defend her and her government's record in relation to the finance sector. As such it provides a catalogue of recent legislative measures, such as the recent changes to the Securities Markets Act, as well as changes to tax policy and (of course) the introduction of Kiwisaver.

Turning to the establishment and make up of the taskforce, the Minister notes that one reason for establishing the taskforce is so that the private sector can partner with government to seek solutions that will enable our capital markets to grow. The Minister follows the lead of the All Blacks' selectors by not discussing individual selections, or indeed some of Gaynor's preferred candidates, and instead notes that the selection policy was based on a desire to get a diverse input of skills and expert opinion, noting that the taskforce had the opportunity to seek additional participants if they felt that would add strength.

The taskforce is understood to have already begun meeting and there is some suggestion that it may seek to report earlier than its September 2009 deadline. Having said that, there is a lot of work for it to do.

To paraphrase the Minister, the taskforce is not going to be able to cure many of the problems which beset capital markets activity in this country. As well as the legacy issues identified by Gaynor, the wash-up from more recent events is likely to have an impact on the "buy-side" for some time.

The Review of Financial Products and Providers (RFPP)

The Minister's response to Gaynor's open letter provides a timely reminder of the progress of the RFPP and three bills currently before Parliament that go some way towards addressing some of Gaynor's concerns around regulatory protection. These are:

• Reserve Bank of New Zealand Amendment Bill (No 3): This Bill amends the Reserve Bank of New Zealand Act 1989 in order to implement elements of the new regulatory framework for non-bank deposit takers and enhance the Reserve Bank of New Zealand's accountability and transparency arrangements in relation to its financial sector functions.

  It will require non-bank deposit takers (including finance companies) to be licensed by the Reserve Bank, as well requiring directors and senior managers to be subject to a "fit and proper persons" requirement, and comply with minimum prudential requirements which will be set by the Reserve Bank. Enforcement of the new prudential supervision regime will be undertaken and enforced by trustees and the Reserve Bank. In addition, those non-bank deposit takers will continue to be subject to disclosure requirements under the Securities Act 1978 – which are (themselves) expected to get something of a work out as a result of the recent series of failures by a number of high-profile finance companies.

• Financial Service Providers (Registration and Dispute Resolution) Bill: This Bill will require providers of defined financial services and financial services products to be registered as well as providing for supervisory and enforcement functions and will establish a comprehensive, industry-based dispute resolution service with the aim of improving consumer access to redress in the financial services sector.

• Financial Advisers Bill: This Bill aims to:

• ensure that members of the public can make informed decisions in deciding whether to use a financial adviser and in assessing a financial adviser's financial advice (by requiring financial advisers to disclose their experience and qualifications, certain criminal convictions, fees and potential conflicts of interest);

• ensure that people acting as financial advisers have sufficient experience and expertise to provide advice in their particular area – by requiring all financial advisers to be registered and meet certain criteria for receiving and maintaining registration; and

• hold financial advisers accountable for the advice that they give by imposing certain conduct obligations on financial advisers, including obligations to act with integrity, exercise reasonable care, diligence and skill (and prohibit engaging in misleading or deceptive conduct).

There continues to be a broad spectrum of views about the constituent parts of the RFPP, including the timing and content of the proposed new regulatory regime affecting the financial advisory sector. The key message that can be taken from the Minister's reply is that the legislative landscape is about to undergo a fundamental change as a result of the implementation of the next phase of the RFPP.

While it is unlikely that any single development, including the recommendations of the taskforce when they emerge in 2009, will provide a silver bullet, each new development will be regarded by many as an important element in the task of restoring confidence to our capital markets. Without a restoration of that confidence, there remains the risk that savings and investment will continue to "leak" into non-productive activities, such as much of the recent speculative investment in real estate to the detriment of the economy, which will continue to rely on the savings of overseas-based investors to expand.

This article was first published on the Bell Gully website on 6 August 2008.

¹ For a copy of the letter see Brian Gaynor: An open letter to Lianne Dalziel - 26 July 2008 - NZ Herald: New Zealand Business, Markets, Currency and Personal Finance News

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