Jane Diplock AO
Chairman New Zealand Securities Commission
Executive Committee, IOSCO
Auckland Rotary
22 June 2009
Introduction
Early in April this year, the Financial Times reported that the end of the world had been cancelled "for now". That being so, I am particularly pleased to be with you all here. The Securities Commission is committed to facilitating New Zealand's capital markets by encouraging good market practice via cost-effective regulation. So I'm glad to be able to share my thoughts with you today.
Rotary International is nearly 105 years old, and boasts more than 1.2 million members world-wide, in more than 32,000 clubs. One of your foundations is the encouragement of high ethical professional standards - something that has a strong bearing on the Securities Commission's work and one that I'd like to address today.
It's fair to say - if I might misquote Mark Twain - that rumours of the death of the global economy were not greatly exaggerated. I'd like to tell you about how I see this extraordinary crisis playing out in New Zealand, and about the work the Commission is doing not just towards curing our current ills but also towards preventing any recurrence.
The global financial crisis
The effect of the global financial crisis on markets here and overseas has been profound and widespread.
Before this happened, New Zealanders faced a home-grown crisis - the serial collapse of a number of finance companies from early 2007 onwards. This was not part of the global crisis - it was a home grown phenomenon. While in dollar terms, these companies represented only a limited part of the capital market, the failures affected many investors. They also had a serious impact on investor confidence generally. It was a result of poor governance in institutions which had a poor regulatory framework. I'll come back to this later.
From my own observations, it's clear that one of the elements that led to the international crisis was macro-economic fiscal imbalances, which resulted in domestic policies that fostered undisciplined credit. Other elements in a chain of causes were: reliance on continuous growth of asset prices; opaque markets that developed toxic, over-valued products that failed to reflect concomitant risk; lack of transparency; inadequate infrastructure; investor greed that sought yield without giving attention to due diligence; and, markets reflecting perceived rather than true value.
There is no question in my mind that a major factor in precipitating the global crisis was the eventual overwhelming by unregulated market forces of traditional, centuries-old standards of conduct.
We are now transitioning from a time when ethics in business - at any level - tended to be seen more as an optional add-on than an essential operating principle. A luxury, rather than a necessity. This has changed and I believe changed for good.
Why the finance companies collapsed
New Zealand is an island only in the strictly geographical sense. In every other way, and particularly when it comes to economics, if the world catches cold, sooner or later we sneeze. We too were in part caught up in the spirit of the times that too often allowed ethics and good corporate governance to be overwhelmed by the drive for gain. So we too have paid a high price by sharing in the downfall.
International research shows that fundamental aspects of corporate governance can play a key role in corporate performance. In other words, outcomes are, to some extent at least, dependent on values.
Our work at the Securities Commission has thrown up plenty of evidence to support this hypothesis. In our view, most corporate failures and breaches of securities law are at least partly attributable to what is at some point a failure of governance.
In the failure of finance companies, we have seen failures to ensure accurate disclosure and financial reporting, particularly in relation to party lending and/or asset quality. We have seen poorly capitalised companies without any liquidity buffer against a downturn. We have seen heroic valuations in a declining market.
There have been instances of too few directors, or even sole directors, on boards, as well as periods when boards included no independent directors at all. In some cases, independent directors failed to ensure they were adequately informed, or they took insufficient interest in the business. Directors are, of course, entitled to receive and rely on expert advice, but I don't believe they should do so blindly. Directors need to critically assess valuations and other external reports, and exercise common sense and good judgment.
We have seen ineffective audit committees, or none at all. And we have seen poor handling of business growth or expansion, and evidence of failure to recognise or act on warning signs in a timely manner.
I am certainly not claiming that all finance company failures were attributable solely to poor corporate governance. But in my view this was in many cases a contributing factor. Whether governance systems are rules-based or principles-based makes no difference. What does make a difference is that there are such systems and that they work properly.
The Commission's role in the aftermath of the finance company collapses
The Commission's task is to ensure risks are properly disclosed so the prudent investor can assess their individual risk in light of the offered return. Where we have cause to investigate we can assess whether or not offer documents are misleading. These include prospectuses, investment statements and moratorium proposals.
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.
So it needs to be said, first off, that the Commission could not have prevented the finance company collapses. Many investors lost considerable sums of money - money that meant more than mere dollars: that represented security, hopes and dreams. Perhaps some of you were affected, and if so, you are understandably outraged. But unfortunately, the Commission cannot intervene to stop a company from failing.
We have, however, done a great deal of work since the collapses. Poor corporate governance very often, directly or indirectly, results in breaches of the law, and some collapses raised serious questions about directors' behaviour. Where breaches have occurred, the Commission can, and does, take action.
We energetically pursue those who have broken the law, and cooperate as fully as possible with other regulators. So, as well as carrying out our own investigations, we have been working with the Registrar of Companies, the Serious Fraud Office, receivers and other agencies to determine whether legal action is called for. 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.
Good corporate governance
Hindsight is not, of course, a particularly clever gift. But surely it is incumbent on us to learn from looking back. Not in order to lay blame so much as to apply lessons to the present. As philosopher-poet George Santayana famously said, "Those who cannot learn from history are doomed to repeat it."
We can no longer cling to the notion that markets will sooner or later correct themselves. The challenge now is to correct the corporate governance that manifested itself in the poor practices that led to the crisis.
John Bogle is one of my colleagues on the international Financial Crisis Advisory Group that reports to the international accounting standards setters and informs the G20 group of finance ministers and central bank governors of its progress. John is the founder and former CEO of Vanguard Group of Mutual Funds in the US, and he has referred to the global financial crisis as "a crisis of ethic proportions".
Now, I feel on safe ground when addressing Rotarians about ethics. Your own four-way test of thought, speech and behaviour is surely one of the most compelling of ethical formulae:
1. Is it the TRUTH?
2. Is it FAIR to all concerned?
3. Does it promote GOOD WILL and BETTER FRIENDSHIP?
4. Will it be BENEFICIAL to all concerned?
Corporate governance is the codification of sound ethical standards. It gives us a common set of guidelines or tools that ensure, as John Bogle puts it, that self-interest does not get out of hand. As a general principle, we need to remember that every decision we make, every initiative we institute, must be soundly based, not just in the pragmatics of profit but also in decent values. At a practical level, good governance embodies the following principles:
fostering and adhering to high ethical standards in every decision we make and every initiative we institute;
How simple and straightforward these principles seem, when stated like this. The challenge lies in putting them into practice, especially when they are most needed - during a financial crisis.
Rebuilding investor confidence
That percipient Financial Times journalist I referred to at the outset reported that investors around the world were discovering they were still alive after last year's near-death experience. It's true that we may now be able to detect the first hopeful signs of recovery. But recovery needs a sound, healthy environment in which to flourish. And good governance is a crucial element of that environment.
Now, more than ever, investors need assurance that issuers have robust corporate governance principles in place. They can only have confidence in the market if such arrangements are fully disclosed.
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. And directors' duties and the enforcement of them are particular issues for us.
You may be aware that in February 2004, the Securities Commission published a set of Principles entitled Corporate Governance in New Zealand-Principles and Guidelines. These Principles apply to every kind of entity, not merely issuers or listed companies, and they are by no means limited to the private sector. Neither are they embodied in law. They are intended to guide the market, and to enhance standards of corporate governance.
The gains here to individuals are obvious: confident, knowledgeable investors will be well-placed to benefit from the eventual economic recovery. But investor confidence is also an essential plank in rebuilding our economy. The upswing we all look forward to will fail to eventuate without investor confidence to prompt it.
The Commission works to strengthen market confidence and foster investment in New Zealand. This, as I emphasised to the Summit on Employment earlier this year, is the only way forward for economic growth, which, in its turn, is a vital step in achieving full employment. So I'd like now to tell you a little more about our current priorities.
The Commission's work
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. Consequently, we have been working with Government and with the Capital Market Development Taskforce on proposed reforms to help firms raise capital and reduce associated costs.
It is important to note that of the top 11 banks in the world currently 4 are the Australian banks operating here in New Zealand. Our banks have suffered relatively far less than those overseas which had large exposures to toxic assets. However, interbank lending has also been constrained and increased margins have made credit more expensive and more difficult to access.
It's important to ensure regulations don't impede access to funds. We are aiming to remove unnecessary barriers without compromising investor protection. Our work here includes streamlining the listing rules to which listed companies are subject, and streamlining rules on raising additional funds from existing investors.
Legislation currently before Parliament aims to remove unnecessary impediments to raising capital, 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, thereby reducing the duplication of information.
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.
The finance company collapses have illustrated the need for a comprehensive regulatory framework. A series of government reforms of securities markets have been aimed at bringing New Zealand's framework up to a high standard. These include regulation of financial advisers, prudential regulation of finance companies by the Reserve Bank and the powers for trustees.
This country's disclosure-based regime for securities regulation relies heavily on the honesty, competence and diligence of directors. Effective enforcement deters bad practices and market misconduct. It may also give affected investors a measure of redress. The Commission's enforcement work will focus on requirements for continuous disclosure, and we will work on the design of new, simplified prospectus requirements. Our finance company work has revealed significant mis-selling of financial products.
Implementing a supervisory regime for financial advisers is vital. New law in this area will allow New Zealanders to be confident in the trustworthiness and competence of the financial adviser industry. Advisers are many investors' main point of contact. They must attain high standards of conduct and be accountable to those they advise. By the end of next year, this country's financial adviser industry will be operating in line with international standards.
The ultimate aim of all Commission work is to help bring about reforms that will give New Zealand a world-class regulatory environment, thereby earning the confidence of both retail and institutional investors, here and overseas.
International work
This brings me to work at the international level. Along with 108 others, New Zealand is a member country of the International Organisation of Securities Commissions (IOSCO). I have the privilege to chair IOSCO's Executive Committee, its governing body. IOSCO is the recognised global standards setter for securities regulation, and its international reach covers more than 95% of the world's securities markets. Its work was recently recognised by the G20 leaders, who have endorsed its initiatives and suggested further work.
IOSCO considers good corporate governance to be the key to capital market integrity and stability. One of its great achievements is having signed up most of its member countries to a multi-lateral memorandum of understand (MMOU). This commits signatories to 30 sound principles of securities regulation, and countries are audited to ensure they are applying these principles on their home turf. The MMOU facilitates cooperation and information exchanges across borders, and New Zealand is, of course, a signatory.
New Zealand's IOSCO leadership role has direct benefits for New Zealand. The Commission understands how important it is for our markets to attract offshore as well as domestic investors and, when abroad, I take the opportunity to speak to key business and investor audiences, working with the Ministry of Foreign Affairs and Trade and New Zealand Trade and Enterprise to promote New Zealand as a sound investment destination. Ensuring potential offshore investors have confidence in our regulatory environment is vital to full employment.
Conclusion
Around the world, we have discovered the hard way that sound ethical practice isn't merely a virtue worth pursuing for its own sake, but an absolute necessity if we want global markets built on strong foundations.
Recovery will come, but it will come more slowly and be less sure without that strong foundation. Sound ethical practice will restore and maintain the balance between hard-nosed pragmatism and traditional standards - a balance that's crucial if we are to regain some semblance of a healthy global economy.
The very word "global" carries with it intimidating suggestions of remote root causes and far-reaching effects beyond individual influence and control. But I would like to suggest we remember that favourite call to action of the environmental movement: Think globally, act locally.
In business, this approach can apply at every level - from the small investor and company director, through to large businesses, politicians and regulators, and regulatory bodies. In the Commission's view, complying with the law is the minimum requirement. Rather, we urge all market participants to aim for best practice.
I firmly believe this is something for which each of us can and should take personal responsibility.
Eighty or so years ago, US president Franklyn D Roosevelt said, "We have always known that heedless self-interest was bad morals; we now know that it is bad economics." He was probably right then. He is certainly right now.
Thank you.