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New Zealand in the international securities marketplace

Jane Diplock AO

Chairman, Securities Commission New Zealand

& Executive Committee, IOSCO

CONFERENZ 5^th Annual Securities Law Update

26 August 2009

New Zealand in the international securities marketplace

Introduction

I'm very pleased to be here today to speak to you about New Zealand in the international securities marketplace. I welcome the opportunity to talk about it with an audience like this one. Before I begin, I want to emphasise two important points.

The first relates to the difficulty people sometimes have in understanding the international context. The misunderstanding arises, I think, from holding onto what is now a rather outdated notion - that national and international markets are distinct, if not actually divorced from each other. This is simply not the case.

These days, markets are vitally interconnected. I use the word vital here in its dictionary sense of alive and dynamic. No longer is there such a clear-cut entity as an individual market - not in an age when money moves around the world at the touch of a mouse, completely unheeding of geo-political borders.

Securities markets truly are global. No country - not even New Zealand - is an economic island. The Commission strives to build confidence in the New Zealand securities market in order to make it attractive to New Zealand and to foreign investors. Our domestic work programme does not proceed down a path that separates us from the rest of the world. Quite the contrary.

The second point I want to emphasise is that the bulk of our work is certainly not dominated by production of a raft of panic-driven regulation in response to the global financial crisis.

The Commission was well on course to bring this country's securities markets up to international standards long before there was any hint of a crisis. We were then and are now focused on putting in place the kind of regulatory framework every capital market needs.

Another work stream flows from the finance company failures. These preceded the global crisis. They occurred in products beyond the coverage of our regulatory framework, and cannot be laid at the door of factors originating overseas. They were domestic in origin.

A third stream of work is indeed prompted by the crisis, which has seen credit channels constrained and companies having difficulty in raising funds from banks. Work in this area focuses on allowing companies to more easily raise capital through securities markets.

A fourth work stream is, again, not merely a crisis response. It involves a major review of our establishing Act. Finally, and again independent of the crisis, we are making significant progress towards a virtual trans-Tasman market.

Before I talk in more detail about these elements of Commission work and how they link to the international scene, I want to address that apparently ephemeral capital market ingredient - investor confidence.

Why confidence matters

Every country's economy relies on a well-functioning financial system. One that allows businesses to borrow and raise capital by issuing securities; that allows markets to trade securities in a fair, transparent and efficient manner; that allows investors to have confidence in the rules of the game.

On a world scale, New Zealand's is small economy. We need foreign investment. That is a fact of life. It's therefore critical we be seen as a world-class securities market in which foreign investors can have confidence. So a large part of the Commission's role is working to enhance investor confidence at home and abroad. It underlies everything we do.

We have all seen what happens when investor confidence is suddenly and seriously undermined. Overnight, it seemed, a massive dive in investor confidence prompted an acute haemorrhage of value in every country in the world. Politicians, regulators, policymakers, businesses and investors ... we have all in some way been affected by what's happened.

Loss of confidence is, in the first instance, intangible, individual, private. When a critical mass experiences this loss as a form of fear, it manifests as a powerful, public, measurable and far-reaching force. The private response translates into a type of herd behaviour that has been observed in a number of contexts, including the market. Behavioural economics has something to teach us here. Once loss-of-confidence behaviour is underway, the effects it creates doubles-back with many times more impact, to be met with more fear and even more pronounced behaviour.

This kind of fear is a deep-seated human response. Can it be susceptible to rational, large-scale solutions? Luckily for us all, it can.

Luckily, because the reverse of the current crisis situation is also true - investors acting without fear, investors confident of protection by appropriate law and regulation, do what we need them to do: they invest. Their investment produces a stable securities market, and that, in turn, produces a healthy, growing economy.

New Zealand had the misfortune to experience the pitfalls of this under-regulation first-hand, before the global crisis hit, with the finance company collapses. What these and the global crisis illustrated is that regulatory coverage was less than ideal, less than consistent, less than was needed to keep securities markets on an even keel.

The investor confidence/financial market stability nexus is crucial, and one a regulatory approach can definitely impact.

In saying that investor confidence is vital, I don't want to be misunderstood as declaring that investment should be bullet-proof. It isn't, nor should it be, and it's not the job of the Commission to strive to make it so. Investors, though, need and deserve confidence that their faith in the rules of the game is not misplaced. Just as much to the point, the rest of us also need them to have that confidence.

Work stream 1: Bringing New Zealand up to world-class standards

As I said, a major part of our work pre-dates the global financial crisis. It focuses on strengthening New Zealand's regulatory framework and enforcing it. We monitor the domestic securities market, advise Government on necessary legal and regulatory changes, work with other agencies on securities-related projects, and develop and implement public investor education programmes.

Anyone who doubts the value of sound regulation need only note that the massive loss of confidence that precipitated the global crisis originated mainly in unregulated and under-regulated financial products.

The last two decades have seen New Zealand move from a light-handed regime to one close to international best practice.

Insider trading and market manipulation

Insider trading is a major risk to the fair, transparent operation of any capital market economy. For the 20 years until early this century, we had a civil sanctions regime that wasn't invoked against anyone for insider trading. Over the last 10 years, the Commission has asked for and been given greater powers to take enforcement action against this practice.

The law has moved away from the idea that liability for insider trading is narrowly restricted to people with a fiduciary duty to, or connection with, a public issuer. Our rules now focus on the public interest.

New law came into force in 2008 following a thorough review of insider trading rules here and overseas. Insider trading is now a serious criminal offence, the law underpinned by the principle that market efficiency and fairness sustains investor confidence in the integrity of the market.

At the same time, other law made market manipulation illegal. It prohibited any behaviour likely to give a false or misleading impression about the supply, demand, price or value of securities traded on a registered exchange.

Enforceable undertakings

Once, when entities breached security laws, the Commission's only option was enforcement, usually via legal action. Since 2002, however, we have been able to oblige entities to rectify their breach. They must commit themselves in writing to doing so, and the terms of their undertaking are published on the Commission's website.

This system has several advantages over enforcement. It can be tailored to the circumstances of each breach. It also avoids the cost and time needed for formal court proceedings. However, if the entity falls down on its undertaking, it will be enforced through the courts.

Disclosure

Appropriate disclosure by those offering securities is a cornerstone of any system of investor protection. It's too easy to assume - or kid ourselves it's fair to assume - that potential investors fully comprehend the product they are investing in and all its implications. Too easy to invoke the old maxim - caveat emptor: let the buyer beware.

A major difficulty is that many investors don't know what they don't know. Looking back again at what contributed to the current crisis, we see products becoming more complex and harder for ordinary investors to understand, at the same time as the sell also got harder.

The time is long past when it's enough merely to answer direct questions: offerers must now go further, by not withholding any information relevant to an investor. Law that came into force last year subjects investment advisers to fuller disclosure and obliges listed companies to continuous disclosure. The market must be fully and immediately informed about company ownership and control.

Good corporate governance

This country's disclosure-based regime for securities regulation relies heavily on the honesty, competence and diligence of directors. In April 2004, the Commission published and distributed Corporate Governance in New Zealand - Principles and Guidelines. This handbook for directors, executives and advisers described nine key principles we consider essential to sound governance.

This isn't the time or place to detail those principles. Suffice it to say that my colleagues and I are even more certain now than we were when the booklet was first published that sound governance must underpin a thriving securities market.

The principles are intended to encourage individuals and boards to aim for best practice in their day to day dealings. To put ethical concerns right up there with business goals. For virtue's sake, but also because international studies have shown that good corporate governance adds value and increases returns.

Listed companies are required to report on corporate governance, and we are reviewing that disclosure along with our accounting reviews on accounting issues. The Commission would like to see other entities opting to implement corporate governance reporting too. Our work has shown us again and again that most corporate failures and breaches of securities law are at least partly attributable to what is at some point a failure of governance.

Financial adviser industry reform

Some of you may remember that in 2003 this country's financial sector was thoroughly reviewed under a programme developed by the IMF and the World Bank. The aim here, as elsewhere, was to examine our regulatory framework in order to determine our key vulnerabilities. New Zealand received what was basically a good report. We were, however, recommended to do further work on regulating financial intermediaries.

You will be aware of the financial adviser reforms now underway. These are a direct outcome of that assessment carried out six years ago.

The Financial Advisers Act passed late last year will bring us into line with international standards. It is expected to be operational by the end of 2010. It makes the Commission the industry's main regulator. It requires advisers to attain specified standards of competence, professional conduct and disclosure, and makes them responsible for the quality of their advice to clients.

The complementary Financial Service Providers (Registration and Dispute Resolution) Act, also passed late last year, requires providers to be on a national register and enrol with an independent resolution services, to ensure that, should things go wrong, consumers have access to low-cost redress.

I dare say you can imagine the intensity of our programme over the next 18 months as we work with the industry and others to implement this new system. The results, though, will pay huge dividends in investor confidence.

Enforcement and surveillance

Sound laws and regulation are not enough, on their own, to enhance investor confidence. If they are not enforced and enforced promptly, they can have the opposite effect. Effective enforcement deters bad practices and market misconduct. It may also give affected investors a measure of redress.

Surveillance and enforcement account for more than a third of our resources. Before June last year, we lacked the powers to take criminal prosecutions, and worked with the Registrar of Companies. Now we can prosecute misconduct in the criminal as well as the civil courts. A huge amount of work has been done and remains to be done.

Registrar of Companies prosecutions arising from our investigations amount to more than 160 charges laid against 13 directors of eight companies. The Serious Fraud Office also achieved a recent conviction on the basis our investigation. The Commission itself has laid 71 charges against nine directors of two companies - Bridgecorp and Nathans.

Other work

We have also been working on a Ministry of Justice-led project to strengthen New Zealand's law on anti-money laundering and countering the financing of terrorism. We expect appropriate legislation to be passed by end of the year. It will make the Commission responsible for supervising some institutions for anti-money laundering compliance.

Work stream 2: Aftermath of the finance company failures

As I said at the outset, the finance company failures pre-dated the global crisis, and arose entirely from a lack of domestic regulation in this area. This was a truly home-grown phenomenon.

Over the course of a couple of years, 29 New Zealand finance companies holding around $1.5 billion of investors' money either collapsed or froze repayments. In dollar terms, this represented only a limited section of the capital market, but the failures affected many. Not least because they had a serious impact on investor confidence generally.

Some of those unlucky investors may be in this room; more of you will know or know of people whose lost money. Some might see 7.5c, 40c or 65c for every dollar they invested.

This is uncomfortably close to home. Not just uncomfortable in the sense that we may have suffered direct losses ourselves or know someone who has, but uncomfortable because we may also know or live near or have done business with one or more of those whose behaviour was responsible for these collapses and their fallout.

The finance company collapses were not just bad luck. Quite often they were precipitated by directors' failure to act - their failure to do what was required to protect investors and, finally, the companies themselves. I am not claiming all finance company failures were attributable solely to poor corporate governance. But in my view this was often a contributing factor.

Something people don't always understand is that the Commission could not have prevented these collapses. We cannot intervene to stop a company from failing. That is entirely outside our mandate.

Our task was and is to ensure risks are properly disclosed so the prudent investor can assess their individual risk in light of the offered return. Given cause to investigate we can assess whether or not offer documents such as prospectuses, investment statements and moratorium proposals are misleading.

Once the offer is allotted, this role ceases and we have no other role throughout the life of the investment. Trustees are given oversight of the product and of the behaviour of directors throughout the product's life.

Some collapses, though, as I've suggested, raised serious questions about directors' behaviour. Since then, a good deal of the enforcement work I described before has been a follow-up to the collapses. Where legal and regulatory breaches have occurred, we will, and do, take action. We energetically pursue those who have broken the law, and cooperate as fully as possible with other regulators.

As I noted before, in December the Commission laid civil and criminal charges against nine directors of two failed finance companies, Bridgecorp and Nathans Finance. We allege that untrue statements published in their companies' offer documents misled investors.

Under law that came into force early last year, the Commission has the power to take civil action where companies' offer documents were registered or their advertisements distributed after October 2006. We can apply to the court for pecuniary penalty orders and, in some circumstances, for orders to compensate investors. We are determined to ensure that we bring to account those whose actions led to investor losses, and to the ensuing wider loss of confidence in the market.

Our work continues in this area - many other finance companies are still under close scrutiny by the Commission.

Work stream 3: Responses to the crisis

New Zealand businesses have come under a lot of stress from economic conditions caused by the global crisis and report difficulties in raising and rolling over funds.

Four of the world's top 11 banks are the Australian banks currently operating here. Our banks enjoy some of the world's highest credit ratings, and, unlike some overseas banks, have not required public money to prop them up although deposits have been guaranteed and credit has been more difficult and expensive to obtain.

The Commission has a strong interest in helping deep liquid capital markets that have the confidence of investors. To this end, we work with the Government and the Capital Market Development Taskforce to propose reforms that will allow firms to raise capital and reduce associated costs.

Our work here includes streamlining the listing rules to which listed companies are subject, and streamlining rules on raising additional funds from existing investors.

The Minister referred to the legislation aiming to remove unnecessary impediments to raising capital, while ensuring prospective investors have access to the information they need. It allows businesses listed on the New Zealand Exchange to use a simplified disclosure prospectus when offering securities to the public, thereby reducing the duplication of information. The Regulations come in to force on 1 October.

We have recently used our exemption powers to allow a number of companies to raise money from the public quickly and cheaply, while still ensuring investors get the information they need. This allows them to reduce the costs of bringing onto the market new and overseas investment products.

As you're aware, last October the Government followed Australia's move to introduce the deposit guarantee scheme. This aimed to ensure continuing depositor confidence in New Zealand. It is similar to the Australian scheme and those schemes now offered by other countries.

The Commission granted two class exemptions to facilitate the deposit guarantee schemes. It also issued a related note to ensure individuals get clear consistent information about the scheme and how it affects their investment.

Work stream 4: Securities Act review

We are working with the Ministry of Economic Development on a wide-ranging review of the Securities Act. The entire regulatory landscape is under review. The Act establishes the Commission itself, so the review will look at the way forward for our role and that of related organisations.

The Government's wide review of the Securities Act will, among other things, look at fund managers and governance of funds, and consider the role of trustees. It may well be that changes introduce trustee supervision by the Commission. Directors' duties and the enforcement of them are particular issues for us.

Before moving on to talk about our fifth work stream, I want to reiterate that it would be a mistake to see this as work done in isolation, our back turned on the rest of the world. Given what I said earlier about the interconnectedness of international securities markets, achievements on the home front have crucial ramifications beyond our shores. Just as progress made - or not made - in other jurisdictions has implications for New Zealand.

Work stream 5: Trans-Tasman initiatives

It's vital that New Zealand contributes to the setting of international standards for securities markets. This makes us standard makers, not merely standard takers. As a small, open market, we need to reflect these standards in our regulations in order to attract capital.

New Zealand is one of 109 members of the International Organisation of Securities Commissions (IOSCO). This organisation is the world's recognised standards setter for securities regulation. Its reach extends to more than 95% of the world's markets. Its standards on information sharing form the planks for jurisdictions to undertake their own mutual recognition regimes.

Here in Australasia we are ahead of the rest of the world. Mutual recognition doesn't demand countries adopt identical legislation. Instead, it allows domestic laws and regulations to reflect national imperatives while simultaneously offering the capacity for cross-border cooperation and enforcement. Enforcement follows the offer, so the home jurisdiction of the offeror can be enforce into the host jurisdiction.

Mutual recognition offers another way forward to recovery by enhancing market liquidity and resilience.

In June 2008, a landmark trans-Tasman mutual recognition of securities offerings regime came into force. This allows issuers to offer securities in both countries using the same offer documents, with minimal additional obligations. Its benefits lie in promoting investment between countries, enhancing competition in capital markets, reducing business costs and increasing investor choice.

The results to date are encouraging, with 40 issuers from Australia and New Zealand making use of the regime. Early indications from research ASIC is undertaking suggest that, as envisaged, many issuers are achieving real cost savings.

Mutual recognition in this area is only one item in a raft of moves towards closer economic relations between the two countries. I believe the concept of mutual recognition can be extended across the whole panoply of trans-Tasman financial services.

An example is regulation of financial advisers. Australia has regulated this sector for a number of years and, as I explained earlier, the Securities Commission is currently working to put the financial adviser law in place here.

Mutual recognition is something of a moving target. Each jurisdiction will be continually making changes to its own regulatory framework, which means mutual recognition relies on strong, trusting communication between them.

Similarity in the two countries' securities sector regulation is an opportunity for trans-Tasman cooperation and enforcement. We have made great progress in cooperating on enforcement activities, which means any crooks who think they can hop across the Tasman and dodge the law will be sorely disappointed.

New Zealand and Australia have strong economic ties, and we are currently working towards a single economic market. Mutual recognition is a significant step towards achieving it. The New Zealand Government has a memorandum of understanding with the Australian that aims at improving the trans-Tasman business environment.

At last week's Australia New Zealand Leadership Forum meeting, ASIC chair Tony D'Aloisio and I informed government and business leaders of significant progress in the ASIC/New Zealand Securities Commission relationship that will eventually give us a virtual trans-Tasman regulatory framework.

We also discussed exploring the idea of joint work on financial literacy. There is a significant need for increased financial literacy on both sides of the Tasman.

Conclusion

I find this trans-Tasman work exciting, not least because it reflects what will become increasingly common internationally. The New Zealand/Australia mutual recognition regime is a wonderful model for a new era: regulatory frameworks that rely on internationally agreed principles; global ideas that can be implemented nationally.

As you will now appreciate, we are doing a good deal more than merely responding to the global financial crisis, although neither are we ignoring it. I hope I leave you with a strong sense that the way forward must be based on a global view.

Thank you.

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