ROCK STAR ECONOMY
Thank you for inviting me to speak to you today.
One of the questions – posed as part of the theme at this conference – is can you have confidence the regulatory environment?
Indeed, this is a good point in the investing cycle to ask the question and I guess that although ours will not be the only view – we at the FMA ought to have one!
The New Zealand public market is in a strong growth phase.
In the year to date, $5 billion dollars in new capital was listed on NZX's markets.
The total market capitalisation of the NZX – on an equity basis – was up nearly 17% year-on-year as at July. [1]
Even if we should ignore it on the basis it came from across the ditch, right now New Zealand is or at least has been described as the rock star economy among the first world countries.
And – if the public markets are any gauge – the volume is still going up.
So, it’s a good time to reflect on the quality of regulation.
Because every time a retail investor – or a fund manager – invests in a debt or equity offer, they are signalling their confidence in the markets and – implicitly – the quality of the regulation.
If investors had little or no confidence in the regulatory environment, they’d take their money somewhere else.
Or they’d invest in something else.
So, my response to your question today – as to the quality of the regulatory environment – is good news, in general.
The quality of regulation in New Zealand today is much better than it was.
Indeed, we think it is among the best-designed in the developed world for a market of this size and type.
Overall, there are good reasons for investors to be reassured as to its quality.
But I will also add a caution today.
Even the best regulation can’t prevent failures and losses.
That’s particularly so in overly-exuberant markets, where investors and firms lose sight of the fundamental questions they should ask about risk, leading to losses that they could have avoided.
Good quality regulation does mitigate against failures, making them less likely to occur.
And – where there are failures and losses – quality regulation makes it easier to pick up the pieces afterwards.
Quality regulation also allows us to set standards – for firms and professionals – and ensure they meet them.
It makes it easier to take action against misconduct where it occurs.
And – under certain circumstances – good regulation allows the regulator to anticipate problems and act to head them off.
But regulation is not a panacea.
Or a super-guarantee for investors.
Regulation doesn’t displace or eliminate uncertainty.
It doesn’t obviate the need for investors to exercise responsibility for their decisions, and to ensure they understand what they are investing in and the risks that come with that.
REGULATION = GROWING REASSURANCE
Let me make some more detailed observations on the regulation of the capital markets in New Zealand.
There are good reasons to be reassured as to the quality of regulation in New Zealand.
Most of you will know that regulation – as it applies to wholesale and retail markets, and including conduct regulation and prudential regulation – was overhauled from the mid-2000s.
The overhaul was already beginning when the GFC came.
The GFC underlined the point – already recognised by many people in Government, and in business – that New Zealand’s regulatory regime had fallen behind.
It had fallen behind the expectations of investors and firms, and it had fallen behind the range and depth of change in capital markets and finance.
Let me recap – briefly - on what’s changed.
Over the last few years, the Government has established a completely new regulator – the FMA – to provide licensing, compliance, supervision, and enforcement in financial services and the capital markets.
The patchwork regulation of securities and products – including debt, equity, and managed funds - has been rationalised.
This overhaul of markets regulation will be largely complete on the first of December this year, when the second phase of the Financial Markets Conduct Act takes effect.
Securities and products will be regulated on the nature of the offer, not according to the corporate form of the firm or fund making it.
Fair dealing provisions – which took effect from the first of April this year – apply to everyone working in financial services or the markets. [2]
The new clear, concise and effective disclosure requirements – for offer documents – are coming in to effect.
Indeed, the Genesis float earlier this year led the way with an offer document that was easily-accessible for retail investors, and which is a credit to the firm and its advisers.
In the next year or so you’ll see a central register of all offers of financial products – including debt and equity – that will make it possible to access all the information that’s available.
Finally, the other major regulator in financial services – the Reserve Bank – enjoys a wider remit in regulating the balance sheets of insurers and the non-bank deposit-takers, like finance companies.
Even if you stop right there – with a ‘was/now’ comparison – New Zealand has a regulatory regime that we think is among the most well-considered in the developed world.
There are fewer gaps in the regulatory regime. That’s fewer gaps through which poor practices or dubious conduct can slip.
Prudential regulation and conduct regulation are recognised as two ends of the same stick.
So we have firms that are subject to the conduct tests imposed by the FMA to ensure they are behaving lawfully.
And we have firms – not every firm, but key ones – whose balance sheets are subject to scrutiny by the Reserve Bank, to ensure they don’t pose a disproportionate risk to investors and the economy.
There’s two other features of regulation in New Zealand today that I would point out to you, because they underline the quality of regulation.
- Firstly, the law now recognises the rights of everyone who is investing or making offers. More importantly, the law achieves a good balance of those rights.
Investors and their right to quality disclosure – both when they buy and when they own – are recognised.
Finance professionals are recognised. Indeed, many of those professionals are the subject of licensing.
Issuers – that’s firms who are creating debt or equity products – are recognised. Under certain circumstances, those firms now enjoy easier means to make debt or equity offers.
Directors’ duties are recognised.
Indeed, in statute, we have a proportionate liability regime which is in line with similar countries – it can no longer be argued that New Zealand is an especially tough place to be a company director.
And the regulators are also recognised. The FMA has more powers than its predecessors, including powers that allow us to act with immediacy and to act if we anticipate the potential for an offer to go badly off-course.
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The law creates rights and it distributes them.
It’s notoriously hard to get that formula right, especially in something as complex as capital markets.
In this instance, the rights and their distribution is a credit to the people who designed the regime.
Looking back, we can see that the Capital Market Development Taskforce – headed by Rob Cameron – had a clear vision of how to grow our capital markets while ensuring close attention to respective rights. [3]
- Secondly, the regulatory regime recognises that – generally – regulation works best when it has a bigger purpose.
Regulation for the sake of regulation –or regulation that assists a few special interests – is pointless, at least, and financially destructive at its worst.
The FMA is required to regulate for what is – effectively – a macro-economic objective.
Namely, that’s growing New Zealand’s capital markets so we can grow New Zealand companies.
All other things being equal, that should make a bigger economy which brings national benefits.
Successful debt and equity issues by firms – including IPOs for firms that will make a long-term contribution to the economy - are a good result for regulation.
Indeed, the fact that firms and their advisers are willing to run IPOs on the scale we are seeing, suggests that they recognise that the regulatory environment is much better.
Levels of reassurance – among investors and firms – are up.
The regulatory tide is running in our favour.
TURNING DOWN THE MUSIC
So far, so good but… and I’m guessing many of you were waiting for the “but”
One of the roles of a regulator – indeed, a role that is often overlooked – is the requirement to squeeze on the brakes when it’s necessary to do so.
Tim Geithner - who was the Secretary of the US Treasury in the aftermath of the GFC and head of the New York Fed through it – says in his recent book Stress Test that regulators must lean against the prevailing wind in the good times. [4]
Leaning against the wind requires us to point out – emphatically – the risks, and to anticipate failure even when that seems a remote possibility.
Leaning into the wind is especially required when investor confidence is transforming into over-exuberance. When recklessness starts to overtake sober assessments of risk.
William McChesney Martin had a more colourful description of this when he was the Chairman of the Federal Reserve.
Martin is reputed to have said that the job of the Federal Reserve is to take away the punchbowl when the party gets going.
Let me say, I’m not here today to call a halt to the party and I’m not sure I could if I wanted to.
But I am going to suggest turning down the music a little.
Because, one of the flipsides of quality regulation – like that I have just described to you – is investor caution.
Indeed, a capital market that produces consistently good outcomes is comprised of three things: quality regulation, firms subject to good governance, and prudent and well-informed investors.
So, I want to reiterate the imperative for investor prudence and awareness in New Zealand today.
Because the evidence shows that the public equities market is taking off steadily.
New investors are buying and existing investors are buying in greater quantities.
It’s harder to measure accurately the private capital market – including debentures and property syndicates – but we can assume it is also warming up.
To return to Geithner’s analogy, this is a time when the regulator should notice the wind beginning to pick up and start leaning into it.
So, some clear-headed reminders.
……
Inevitably, investors who exercise prudence ask themselves tough questions about the degree of risk they are willing to accommodate, and answer them frankly.
From my own experience – and also from what I have seen as a professional in banking and regulation – I know that risk is very personal.
That’s especially the case for retail and private investors.
One person’s tolerable risk is another person’s idea of potential agony.
A private investor who is contemplating an IPO, for example, should ask themselves how they will feel if the return is considerably less than they anticipated?
How they would feel if they lost all or part of the capital?
How long they are willing to wait for a positive return?
How would a serious loss affect them, their family, their retirement, or their social standing?
Overall, investors – especially private ones – should avoid getting caught up in hype.
Other people may be buying. But that’s not a good reason – on its own – for you to buy.
We all know that following the herd can lead you – blindly – into danger.
But – unfortunately – a lot of investors do exactly that: follow the herd.
The media may be replete with coverage of promising equity offers. But – again – that’s not a good reason on its own for everyone to buy.
Now – more so than in the immediate past – I would encourage private investors to make frank assessments of their risk appetite.
Good professional advice – from a regulated financial advisor – will help you.
Making full use of good-quality disclosure on offers will also help.
However, in the end, prudent investors make their own decisions, having fully assessed how much risk they are really willing to carry.
In the current market – where it would be easy to be distracted by hype – I’d urge investors to ensure they do exercise the maximum prudence.
TWO POINTS ON GOVERNANCE
Finally, I wanted to make two points on corporate governance in New Zealand, at least where it is relevant to shareholders and investors.
- Firstly, the FMA anticipates a steady improvement in the quality of disclosure – and its usefulness for investors – in offer documents, in line with the clear, concise and effective requirements in the Financial Markets Conduct Act. [5]
Indeed, as I noted earlier, we’re already seeing improvements in offer documents.
Some of what we are demanding – in offer documents, and also in company financial reporting – is not easy to execute for firms and their advisers.
We know that.
But making these documents more readable, more understandable, and more widely-read is critical to us.
Continuous disclosure, by listed issuers, remains a work in progress in New Zealand, at least among some firms.
There have been some hiccups recently for example in Gentrack and Lyttleton Ports.
I’m not going to comment on any inquiries we may have underway, or provide an opinion here on any instances.
Nonetheless – judging, for example, from the coverage in the business press – there were investors who were disappointed in the disclosure.
In one instance, the initial disclosure was too little to satisfy investors, with some suggestions that selective disclosure in terms of briefing analysts in greater depth than the public may have been an issue.
In the second case, apparently some investors felt disadvantaged by the way the material information was disclosed to the market.
Last week NZX released detailed guidance – for the purposes of consultation – on the practice of continuous disclosure. [6]
That guidance, when it is settled, will be welcome among firms, advisers, investors, and analysts.
As a statement of principle, everyone needs to apply laser-like focus to the fact that disclosure to the market is critical to shareholders, and that it is also intended to produce an informed and confident market.
No prisoners can be taken in the drive to get standards as high as possible in this space.
I’d like to acknowledge the willingness of NZX to tackle this subject head-on, knowing that it will be debated among directors, company management, and counsel.
In particular, we do and will look at what is said to or given to analysts that is not made publicly available.
- Secondly, as I noted earlier this week – in a speech to the Institute of Directors - we must be willing to face up to our responsibilities in recognising conflicts of interest and conflicts of duties.
Yes, I recognise that New Zealand has a small pool of directors, company officers, and advisers.
It’s often argued that the size of the New Zealand market means conflicts of duty and conflicts of interest will be more prevalent than they are in a bigger society.
That does not mean we should excuse them easily.
We have to be willing to step down or step aside – temporarily and sometimes permanently – where that would relieve actual or perceived conflicts.
I acknowledge the willingness of NZX and the Markets Disciplinary Tribunal to tackle such conflicts, for example in its recent decision on Marsden Maritime Holdings (MMH).
The tribunal found that the role of Marsden’s directors, and the majority shareholder, weren’t separated during a vote on directors’ remuneration, leading to a breach of the Listing Rules.
The complaint was brought – initially – by the Shareholders’ Association.
The tribunal censured Marsden, but declined to impose a penalty. [7]
A note on our own board, at the FMA. Because its composition requires us to be very vigilant in respect of conflicts.
We are blessed with a board that includes – among others – very experienced financial services and legal practitioners.
We don’t have shareholders.
But we do have stakeholders – including all of you – who need to trust the impartiality and objectivity of our decision-making.
Our conflicts procedures are very conservative.
We apply them rigorously.
In our oversight of the NZX, for example, we have had extensive discussions with Tim Bennett, and with the NZX Board, on the need to not only separate out potential conflicts of interests, but to have a governance structure that underlines that.
Those of us that regulate the market have the same obligations as everyone else.
That’s to ensure we are clear as to how we manage these issues, and clear in a way that would satisfy our stakeholders.
CLOSE
Thank you for the opportunity to speak here today.
‘Investors’ are a disparate community.
They range from people who might have a few thousand dollars invested in a stock, that they only remember their investment when the dividend payment appears, through to professional investors who follow markets by the second.
In-between those groups are – among others – fund managers, analysts, legal counsel, and financial advisers.
All of them people who have an interest in the subject of investment.
I imagine that – for the NZSA – it’s tough to be the voice of such a diverse group.
Indeed, it would require patience and attention to maintain a consistent and constructive position when you advocate to regulators, Ministers, firms, and NZX.
So, I’d like to congratulate the Shareholders’ Association for raising the flag – on behalf of shareholders – for 13 years.
Everyone needs to remember that without the shareholders, it all ends.
The issuers, the boards, the lawyers, the accountants and – of course – the regulators.
We all need to keep that at the front of our focus.
And a strong shareholders’ body – like the NZSA – goes a long way to reminding us of that.
Thank you.
[1] All data year-on-year, at July 2014. From ‘NZX report to shareholders July 2014’, NZX Limited, Auckland, New Zealand.
[2] Financial Markets Conduct Act 2013, Part 2.
[3] Capital Markets Matter: Report of the Capital Market Development Taskforce, New Zealand Government, December 2009, Wellington, New Zealand.
[4] Timothy F Geithner, ‘Stress Test: Reflections on Financial Crises’, Random House, New York, 2014.
[5] Financial Markets Conduct Act 2013, Part 3.
[6] See: https://nzx.com/market-regulation/rules-consultation, 26 August 2014, NZX, Auckland
[7] ‘Public censure of Marsden Maritime Holdings’, 21 August 2014, NZMDT 8-2014, NZX Markets Disciplinary Tribunal, Auckland, New Zealand.
