Jane Diplock AO
Chairman, Securities Commission New Zealand
& Executive Committee, IOSCO

Legal Research Foundation Incorporated
Regulation of New Zealand Capital Markets
Auckland
Friday 1 May 2009

The international regulatory environment

Introduction

Good morning. It is a special pleasure to be participating in this conference today and I welcome the opportunity to talk to you all.

Dialogue on the regulation of New Zealand capital markets is very timely and I congratulate the Legal Research Foundation on convening this conference. I should point out that the Securities Commission, as the main regulator of securities markets in New Zealand, facilitates, develops and implements changes that support growth of the capital markets which are fundamental to building the economy. So I look forward to the ensuing discussion.

Today I would like to discuss the international regulatory environment and the role of key players in the emerging global financial architecture and then focus on the potential that mutual recognition offers for the trans-Tasman market.

Allow me to briefly outline the thesis of my discussion. I am convinced that the 20th Century global financial architectural solutions are outdated and have been found wanting. We run the risk of repeating our mistakes unless we look to 21st Century solutions.

The solutions created post 1945 need to be replaced with network solutions reflecting the sort of concepts we see in the internet and developments there. These are not fanciful notions but ones that have already been successfully modelled but in a relatively narrow sphere. What we need is a mechanism by which global concepts or standards can be implemented universally in every jurisdiction around the world.

Financial stability is everyone's concern. The underlying foundation of the entire financial system has been exposed to severe risk and it has taken an extreme series of government bailouts and bank acquisitions around the world to attempt to rescue it. The challenges of the current crisis are front of mind for all of us - politicians, regulators, policymakers, businesses and investors alike. We are all touched in one way or another.

G-20 Leaders recently pledged to do whatever is necessary to restore confidence, growth, and jobs. To grow, any country's economy today relies on a well functioning financial system that enables businesses to borrow and raise capital by issuing securities, and markets where securities can be traded in a fair, transparent and efficient manner. G-20 acknowledge that growth cannot return until domestic lending and international capital flows are restored.

So the multi-trillion-dollar question remains - how do we build confidence in the financial system, including capital markets?

Capital markets and financial stability

Financial stability is underpinning every effort in finding solutions to the global crisis. It is therefore timely to address issues surrounding capital markets, pro-cyclicality and fair value, to name but a few issues that urgently retain our attention and have been much commented on.

All too often, we see policymakers and commentators confining financial stability to the domain of banking and prudential supervision frameworks. However, one thing the global crisis has clearly demonstrated is that capital markets form a vital part of the equation.

Much of the harm in the financial sector has come from loss of confidence in markets and intermediaries driven by conduct issues such as conflicts of interest, malpractice, and unethical behaviour.

The global crisis will not be resolved without restoring confidence in capital markets and in the way the various market players conduct their business. Restoring confidence in capital markets requires enhanced securities regulation and supervision in a coordinated fashion at the global level, and independent, strengthened, and well-funded regulators for implementation at the domestic level. It also requires greater coordination between regulators and standard setters in the securities, banking, and insurance sectors, and political will for implementation of international standards.

Strengthening financial regulation - who does what?

Efforts to understand the crisis and find solutions are being coordinated by various international bodies and standard setters working within their respective remits, with their own constituents and with others. They include the International Organisation of Securities Commissions (IOSCO) and the International Accounting Standards Board (IASB).

Other groups have been specifically set up in response to the crisis.

The Financial Stability Board

The newly formed Financial Stability Board (FSB) was created by the G-20 as an enlarged version of the Financial Stability Forum. Forum Chairman Mario Draghi has recently noted that the board will "promote and help to coordinate the alignment of international standard setting activities to address any overlaps or gaps and clarify demarcations in light of changes in national regulatory structures relating to prudential and systemic risk, market integrity and consumer protection, infrastructure, and accounting and auditing".

The formation of the FSB is an extremely important development in global coordination and one which has been welcomed by IOSCO. It is a critical new participant in the global financial architecture and its broadened remit will advance and hopefully accelerate the implementation of global financial standards, amongst the G-20 membership and more broadly. The encouragement of the use of the FSAP (Financial Sector Assessment Programme) as a global benchmarking tool by the G-20 Leaders and the FSB is extremely welcome. I will expand on this shortly.

As the international standard setter for securities regulation, IOSCO sits on the FSB and works with its sister organisations responsible for setting standards for the banking and insurance sectors, the Basel Committee on Banking Supervision and the International Association of Insurance Supervisors respectively. IOSCO also works with the IMF, the World Bank, the OECD and the regional development banks, each of which have their own place within the global financial architecture

The Financial Crisis Advisory Group

Another body, the Financial Crisis Advisory Group (FCAG), was set up in December by the International Accounting Standards Board (IASB) and the United States Financial Accounting Standards Board (FASB). This Group, which I have the privilege of being a member of, will be reporting back to those boards mid year about standards setting implications of the global financial crisis and potential changes to the global regulatory environment.

Of particular interest to the Group are issues around fair value accounting and mark-to-market and the role these issues played in the financial crisis; consolidation and de-recognition of assets related to special purpose vehicles; and financial instruments. Also questions of financial institutions being encouraged to make greater capital provisions during good times in order to be better resourced in downturns, and whether this might be encouraged by prudential requirements or accounting treatments, have been strongly debated.

It is my personal expressed view that restoring investor confidence should be the number one priority for standards setters when considering any changes to reporting standards.

IOSCO and G-20 process

I would now like to highlight what I believe is the pivotal role IOSCO will play going forward. Many of you will be aware of IOSCO and its work. I have the privilege of chairing the Executive Committee of IOSCO, its governing body. Its member agencies represent 109 jurisdictions, including 81 from emerging markets, and regulate together more than 95% of the world's capital markets. IOSCO leads the thinking on ways to address the challenges for securities regulators amid today's capital market instability.

The set of regulatory principles developed by IOSCO are among the key International Standards and Codes that the G-20 Leaders are keen to see implemented and peer-reviewed through the Financial Sector Assessment Programme (FSAP). This programme conducted jointly by the IMF and the World Bank consists of a comprehensive assessment by international experts of the financial regulatory framework of countries who voluntarily submit to it. The assessments help identify the strengths and vulnerabilities of a country's financial system and seek to determine how key sources of risk are being managed. This helps governments to prioritize policy and ascertain requirement for assistance. In the ten years since the programme has been established, about three-quarters of IMF and World Bank member countries have completed or requested an initial assessment.

I should point out that New Zealand was assessed in 2003 and Australia in 2006.

Similarly, IOSCO has a programme of assisting members to assess their securities regulation against the IOSCO Principles.

The G-20 has recommended all its members submit to an FSAP and that other countries either engage in a self-assessment or an FSAP using the IOSCO Principles.

This brings me to the IOSCO Objectives and Principles of Securities Regulation and its related IOSCO Assessment Methodology which together provide the benchmark against which the securities sector is assessed.

I believe the IOSCO Principles align well with G-20 Leaders' aspirations. The Principles recognise that securities regulation should have three objectives: the protection of investors; ensuring that markets are fair, efficient and transparent; and the reduction of systemic risk. To help achieve these objectives, IOSCO has developed 30 broad Principles for securities regulation for full implementation in the regulatory framework of every member jurisdiction. I should say these Principles do not constitute rules and regulations aimed at achieving convergence between regulators. They are rather a set of benchmark standards against which any jurisdiction is able to measure and align their own laws in a manner consistent with their own priorities, traditions, market developments and conditions and legal frameworks.

To keep pace with market developments and regulatory thinking, the Principles are organic and updated regularly.

National implementation of global solutions

While global solutions and coordination by the FSB are very important, implementation remains a domestic concern.

The pace of the spread of systemic risk through the banking and capital market systems of the world heralded a call for a global solution. Some called for a global regulator to be set up. Some called on the IMF to take on this role, but the difficulties posed by the tension between a global solution and national jurisdictional remit of regulators and supervisors have been clearly exposed.

There are a number of possible ways in which global ideas can be implemented in each jurisdiction. To be viable any solution needs to use the domestic legal framework and allow political concerns to be addressed.

Despite the high level of coordination provided by the FSB it's my personal view that it remains unlikely that national authorities will cede jurisdiction to any global regulator. Yet, the tension between globalisation and domestic implementation has never been more obvious.

It's here that I believe we should look to 21st Century solutions. Just as the internet is not one central brain but a vast network, so regulation underpinned by appropriate global standards, implemented in every jurisdiction and audited by external experts (such as through the FSAP process) could provide a global virtual "super regulator".

The answer lies, to my mind, in a framework already modelled by IOSCO. In 2005 IOSCO decided that every one of the 109 member jurisdictions should have implemented the requirements of its Multilateral Memorandum of Understanding concerning Consultation and Cooperation and the Exchange of Information (MMOU) or have established a clear plan for implementing them by 2010. In 2005 it may have appeared fanciful that the exchange of information requirements outlined in the IOSCO MMOU would be implemented in all member jurisdictions by 2010 or be promised to be. Strict auditing needed to be undergone to ensure a jurisdiction had complied with all the requirements before it was allowed to sign the IOSCO MMOU. Some jurisdictions had banking secrecy laws they needed to change, others had other difficult legislative amendments, yet it looks as if the goal will be achieved. It has been a Herculean task. Today the principles reflected in the IOSCO MMOU are implemented in the legislation of 52 jurisdictions with 21 more promising to do so.

This is a model which could work more broadly.

Accounting convergence

Another important model is explicit in the current journey towards globally harmonized accounting standards. The convergence of the International Financial Reporting Standards (IFRS) and the US Generally Accepted Accounting Principles (US GAAP) will provide one global set of high level standards. It is vital that the political exigencies of the crisis do not undermine or derail this very important process. There is a risk of a race to the bottom if political interference disrupts or is perceived to disrupt the independence of standards setters and the due process these standards deserve. The risk that investors doubt the validity of accounts could undermine the confidence essential for the recovery. To my mind acceleration of the road map to convergence of IFRS and US GAAP is essential.

The Financial Crisis Advisory Group (FCAG) has stressed the importance of this convergence.

Just this week the Group wrote to the chair of the leaders of the G-20, the Rt Hon Gordon Brown, advising that it has strongly encouraged the two Boards (the IASB and the US FASB) to continue to act promptly and responsibly to address financial reporting issues arising from the crisis. However the Group believes that the more significant, lasting and global improvements are those that will stem from financial instruments and consolidation/derecognition projects and that these should be the priority for both Boards. Further, the Boards need to focus their attention on the highly complicated technical work involved in these important projects (particularly the financial instruments project) if inevitable delays are to be avoided.

My own view is that the standards need to be durable and sustainable as they are imported into the regulations and laws of many countries around the world.

Mutual recognition

I'd now like to turn to what I believe is another way forward to recovery and that is mutual recognition of regulatory frameworks between jurisdictions which can effectively enhance the liquidity and resilience of markets.

Mutual recognition does not require the adoption of identical legislation. Rather than envisaging standardized model frameworks across jurisdictions, it allows domestic laws and regulations to reflect national imperatives while providing the capacity for cross-border cooperation and enforcement.

Trans-Tasman mutual recognition

Many of you will be aware that in June 2008, New Zealand and Australia saw the coming into force of a regime of mutual recognition of securities offerings (MRSO). This landmark agreement allows issuers to offer securities in both Australia and New Zealand using the same offer documents with minimal additional obligations. The benefits sought by such arrangements are to promote investment between the countries concerned, enhance competition in capital markets, reduce costs for businesses and increase investor choice. The results to date are encouraging, with several offers having been made across Australasia.

The mutual recognition of securities offerings underpins the strength of each country's regulatory regime and the co-operative relationship between the two nations.

But it doesn't end there. I believe that we should extend the concept of mutual recognition across the whole panoply of trans-Tasman financial services. An example of this would be in the regulation of financial advisers. Australia has regulated this sector for a number of years and here the Securities Commission is currently working to put the financial adviser law in place. When the law is in force the Commission will be responsible for authorising advisers and monitoring their conduct and competency requirements. Incidentally, this legislation addresses the shortcomings raised in the New Zealand FSAP evaluation conducted by the IMF in 2003. We should follow this with mutual recognition of other financial services.

Close equivalence in the regulation of the securities sector in our two jurisdictions presents the opportunity for trans-Tasman cooperation and enforcement.

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

The Australia New Zealand Leadership Forum which meets annually plays a major role in bringing together key stakeholders from business, government, academia, and the media to discuss matters such as this.

In the capital markets arena, the Commission and its counterpart, the Australian Securities and Investments Commission (ASIC) are working together in the interests of a single economic market. The commissions hold two joint meetings annually and at the meeting in March decided that the focus of work for the next three years would include, amongst other things, an operational review of the MRSO and the establishment of a joint agency group towards the development of a regulatory framework for mutual recognition of advisers.

In fact, one of the strategic issues the Minister of Commerce Hon Simon Power has asked the Commission to turn its mind to, is building on the work of the trans-Tasman MRSO.

IOSCO and mutual recognition

It is clear that, to work effectively, mutual recognition requires coordinated responses and consistent approaches to regulating cross-border transactions. As a first step to achieving mutual recognition, there must be agreement on a common basis of principles on which to assess the effectiveness of foreign regulations and the work of the foreign regulator. The IOSCO Principles provide such a basis. Another important element of any mutual recognition arrangement will, of course, be the ability for regulators to share information and cooperate to engage in effective enforcement across borders. The IOSCO MMOU provides a fundamental tool to achieving this.

Mutual recognition provides a framework to leverage on the strength of markets around the world - bringing diversity, driving best practice and efficiency and opening up a multitude of opportunities for the local financial services sector, business and consumers.

As a result, it is likely that a market value will emerge for participation as may be the case for the IOSCO MMOU. In turn, policy-makers will wish to ensure that the benefits of greater liquidity flow to their domestic markets. It will be the demand from market participants which is likely, in my opinion, to provide the political will in jurisdictions to undertake these exercises.

Significant discussions on mutual recognition arrangements were commenced by a number of jurisdictions prior to the crisis. These discussions appear to have stalled but should be recommenced as this network solution will provide benefits to market participants and investors.

The challenges for recognition agreements between jurisdictions which do not have close ties in other spheres may be difficult, but the success of the IOSCO MMOU demonstrates that members of IOSCO can, and do, work together even though the foreign policy of the various governments may differ.

Risks of protectionism

I believe comity in the regulatory space should become even more important as a result of the crisis and should extend through mutual and unilateral mechanisms. The arrangements will vary but underpinning them will be adherence to the IOSCO Principles and signature of the IOSCO MMOU.

Just as there have been concerns in relation to the global free trade agenda that the financial crisis may precipitate a return to trade protectionism, similarly any suggestion of regulatory protectionism should be resisted. There have been enormous strides made in the global regulatory reach reflecting the global developments of markets, and it would be extremely disappointing if this success was undermined. Any move in this direction would also be likely to increase costs for global financial players at the very time that they are trying to successfully emerge from the financial crisis.

New Zealand actions

On the home front constrictions in credit channels have highlighted the need to free up capital for New Zealand businesses.

The Commission is working with the Government and Capital Markets Development Taskforce on ways to make capital raising easier for companies and to reduce associated costs. The Commission has exemption powers which may facilitate immediate implementation of some recommendations made by the Taskforce. Recently exemptions have been used by a number of companies seeking to raise money from the public.

The Commission expects very soon to settle the policy of a new class exemption that will increase the amount listed companies can raise via a share purchase plan.

Other legislative work in the interests of developing market liquidity includes a review of securities regulation to simplify and clarify disclosure requirements and a wider review of the Securities Act.

The Securities Disclosure and Financial Adviser Amendment Bill, currently before Parliament, aims to remove unnecessary impediments to capital rising, while ensuring prospective investors have access to the information they need. It would allow businesses listed on the New Zealand Exchange to use a simplified disclosure prospectus when offering securities to the public, reducing the duplication of information.

Going forward

Looking ahead at the international setting, IOSCO has started a process of reviewing its strategic direction for beyond 2010. It is indeed timely to start identifying our vision beyond this decade as we learn the lessons from the global financial crisis. This will lead to greater focus on issues of stability in capital markets.

It seems there is no doubt that there will be the need for IOSCO to contribute significantly towards strengthening confidence in the global financial markets and to do so, we might need to find new and different mechanisms for global oversight. There is also no doubt that reduction of systemic risk, efficient, well-functioning markets and investor protection will remain at the heart of our mission.

Meanwhile, in our corner of the world there is a real opportunity to capitalise on the strong trans-Tasman relationship and build mutual recognition arrangements.

Conclusion

The regulatory solutions for the 21st Century are definitely going to be significantly different from those of last century. While there will be greater coordination and cross-sectoral work at the global level, it will remain the obligation of national regulators and policy-makers to bring about change on the ground. It is my belief that a series of networked solutions will be developed and these solutions will require the cooperation of all major players in the global financial architecture as well as commitment at national jurisdictional level. To be effective these solutions will require robust, high quality, global standards constantly updated to reflect market changes, effective enforcement capacity across borders and watchful eyes and actions across the world on stability issues.

Thank you.

Return to Index