In this update, senior associate Stephen Layburn discusses four recent developments which impact on the finance company sector, namely: the extension of the retail deposit guarantee scheme; a proposed new licensing regime for corporate trustees who supervise debt issuers (including finance companies); the introduction of regulations which will simplify and clarify disclosure obligations for finance company moratorium proposals by the end of the year; and the Commerce Select Committee's inquiry into finance company failures.
Extension of retail deposit guarantee scheme
In August, the Government announced a 14-month extension to the retail deposit guarantee scheme, together with a number of proposed changes to the scheme's terms and conditions. (See the article Crown Guarantee Scheme - an overview in the Spring 2008 Commercial Quarterly for details on the current scheme.)
The announcement of the extension of the retail deposit guarantee scheme has ended speculation about the fate of the current scheme, which ends in October 2010 and, once enacted, will bring the arrangements in New Zealand closer to Australia's extended deposit guarantee scheme.
The extension (described by the Government as a new scheme) will run until 31 December 2011 and has the stated objective of continuing the original objectives about maintaining stability and confidence in New Zealand's financial institutions whilst seeking to remove some of the distortions inherent in the current scheme. It also addresses concerns about the allocation of the costs of the scheme.
Finance Minister Bill English says the extension will help financial institutions achieve "an orderly exit from the scheme" and "allow both depositors and financial institutions to adjust back to a more normal business environment".
The changes announced by the Minister that will take effect under the extended (new) scheme are:
A requirement for participating deposit-taking institutions to have a credit rating of BB or higher whereas those institutions with a lower credit rating (or no rating) will not be eligible despite being included in the current scheme.
A change to the fees paid by participating institutions to reflect their risk profile (effectively the lower the credit rating the higher the fees payable). These fees are described as being intended to approximately match longer term normal market pricing. Thresholds in the current scheme will be discontinued and the fees will apply to all funds in the new scheme.
A reduction in the level of coverage, from the maximum under the current scheme of $1 million per depositor per institution, to:
a maximum $500,000 per depositor per institution for eligible bank deposits; and
a maximum $250,000 per depositor per institution for eligible non-bank deposits.
Collective investment schemes will not be eligible under the new scheme.
When announcing the extension, the Minister noted that some institutions may choose not to apply for coverage under the extended scheme whilst others will not meet the application criteria. Further, as credit conditions improve some financial institutions also may decide that participation is not worthwhile.
Since the Minister's announcement, market commentary has been mixed with concerns being voiced that by simply following Australia and not extending the scheme for a longer period, the Government risks jeopardising the long-term survival of a sector that may prove to be vital for SMEs as they emerge from the recession. In particular, it seems likely that the major trading banks will opt out of the scheme because they will no longer need it. At the other end of the spectrum, a number of smaller finance companies will not achieve the minimum credit rating requirement.
Those commentators who express concern that the scheme should be continued for longer point to distinctions between Australia and New Zealand and the significance of the non-bank finance sector as a source of expansion capital for SMEs, particularly given the likelihood that the de-leveraging exercise being undertaken by the major banks may see New Zealand SMEs more reliant on finance company funding.
Given the present difficulties being encountered by finance companies in seeking to realise assets taken as security, concerns have been expressed that by effectively requiring this process to have been completed by December 2011 the Government may not be allowing sufficient time for a recovery of both the profitability and confidence that will be needed to enable finance companies to go to the public for deposits without the safety net of the government guarantee.
On the other side of the ledger, others point to the steps being taken by some of the major finance companies to sure-up balance sheets through injections of capital by shareholders and express concern that the taxpayer should not be taking on the risk of the smaller firms.
Legislation will need to be introduced to enact the changes to the current scheme, which are to take effect from 12 October 2010.
New regime for corporate trustees and statutory supervisors
On 26 August, Commerce Minister Simon Power announced that the Government has agreed to a new regime for corporate trustees and statutory supervisors who supervise debt issuers and some collective investment schemes.
The new regime, will involve the licensing of trustees by the Securities Commission, and a range of measures to strengthen the quality of supervision provided by trustees.
In making the announcement, the Minister said that the recent collapse of a large number of finance companies has raised some fundamental issues around the role of corporate trustees, and in particular the competency and accountability of some trustees. Consequently, he said, the new regime will ensure that trustees are suitably qualified and have rigorous systems and processes in place to protect the interests of investors.
Central to the new regime is the removal of the automatic right for trustee corporations to supervise issuers of debt and some collective investment schemes. Instead, trustees will be licensed by the Securities Commission which will have the power to tailor licences so trustees have processes in place that are in proportion to the level of risk associated with the issuers they supervise. It is understood that, in doing so, the Commission will take into account matters such as the trustee's competence, systems and processes for supervising issuers, and financial strength.
Additional measures to improve the quality of supervision provided by trustees, referred to by the Minister include:
enhanced powers of enforcement against trustees who fail to comply with their duties;
greater prescription around matters that must be addressed in trust deeds;
mandatory reporting by trustees to the Commission when issuers of securities may be nearing default; and
enabling the Commission to direct trustees to take action against issuers.
The Minister also noted that the new regime, whilst contributing to ensure that trustees' supervision of debt issuers and some collective investment schemes is effective and protects investors, would not impose unnecessary compliance costs. He added that mandatory reporting by trustees to the Securities Commission will help ensure proactive action is taken to protect investors' interests.
Legislation is expected to be ready for introduction to Parliament by the end of the year.
Finance company moratorium proposals
Commerce Minister Simon Power also announced in August the pending arrival of regulations to govern disclosure obligations for finance company moratorium proposals. In simple terms, these moratorium proposals provide investors with a choice between a moratorium (forgoing interest or principal repayments (or both) for a period of time) and a receivership. To date moratorium proposals have been used by 12 finance companies with approximately $2 billion involved.
The Minister has said the regulations will ensure that key information is available to investors who are being asked to decide whether to approve a moratorium proposal affecting their investments. At present those decisions are the subject of what he described as onerous and highly complex disclosure documents. Instead, the new regulations will require debt issuers to provide clear and concise investment statements about moratorium proposals, along with independent expert advice, the views of the trustees, and the considerations of the company directors.
Central to the new disclosure regime are concerns that the material currently being circulated does not provide investors with the appropriate information to make sound decisions. (For details on the current requirements for moratorium proposals see the article Moratorium proposals: what do investors need to know? in the Summer 2009 Commercial Quarterly.) As a result, the new regulations will seek to ensure that the right information is made available in a transparent and easy-to-understand way.
Inquiry into finance company failures
On 20 August, the Commerce Select Committee, chaired by former Minister of Commerce Lianne Dalziel, initiated an inquiry into finance company failures. The committee announcement referred to four areas which, it said, did not appear to have been addressed by previous and current government programmes.
The four broad areas identified are aimed at ensuring:
Based on these areas, the committee has set the following terms of reference for the inquiry:
To examine the quality of information provided to investors when considering an investment decision and investors' ability to understand financial matters. This workstream includes an examination of the role of marketing and advertising of investment proposals, adequacy of disclosure (particularly about advisers' commissions) and investor education issues.
To examine the quality of advice provided to investors in moratorium situations, including independent analysis of moratorium versus receivership and the independence of the management of the moratorium.
To examine ways of minimising the chances of situations arising where the risk of failure is not adequately reflected in the risks identified to investors or the returns investors expect to receive for that level of risk. This workstream includes examining the power of regulators to "call in" particular products that may raise investor protection issues, extended whistle blower protections and whether directors and managers implicated in "inappropriate activity" should be able to start up new firms.
To examine the measures in place that provide redress to investors where failure occurs and wrongdoing is established, particularly whether these measures act as a significant disincentive for wrongdoing to occur. This workstream includes questions about the holding of appropriate professional indemnity insurance, the tracing of funds following a collapses and the scope for "busting" asset protection trusts set up by culpable directors.
At first glance, the terms of reference are an unusual mixture of matters that cut across work being undertaken by the Ministry of Economic Development in its 'root and branch' review of the Securities Act as well as the proposals for regulation of disclosure requirements applying to finance company moratorium proposals (noted above).
Since the select committee's announcement, there have been reactions from market commentators to the effect that much of the content of the terms of reference are populist and a reaction to the lobbying of finance company activist Suzanne Edmonds (who petitioned for a Royal Commission of inquiry to investigate the finance companies crisis).
Whilst there is some merit to the concerns being raised about the width of the terms of reference for the inquiry and risk that considerable time and effort will be taken up addressing issues which will not be solved overnight (such as the relatively low levels of financial literacy amongst the investing public), there is no doubt that the failure of so many finance companies has impacted a large sector of the public.
Therefore, there is a view that while it may be less than perfect, the inquiry provides those affected with an opportunity to share their concerns and perhaps, as a result, may achieve a greater degree of buy-in to the findings and any recommendations which may result.
Contrast this approach to the Russell inquiry in the aftermath of the 1987 sharemarket crash, which did not provide the same level of transparency and was later criticised for producing a series of findings which were self-evident and recommendations which were quickly forgotten.
The select committee inquiry is likely to run for some time. As a first step, submissions on the terms of reference are required by 15 October 2009.
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