17 March 2011

Presentation by Sean Hughes to the New Zealand Capital Markets Forum

Thank you for inviting me to speak today. I'm delighted to say this is one of my first public addresses since taking up my role just eight weeks ago.

It's a great pleasure to be here with you all as Chief Executive-Designate of what will soon be New Zealand's new Financial Markets Authority.

In these difficult times for our country and our economy, and indeed for the Asia Pacific region due to the calamitous events unfolding in Japan, I am mindful of stretching analogies too far. But, as capital markets participants, you more than anyone are intimately acquainted with the raw realities of the market - that some companies steer well clear of disaster through careful prudent management; others teeter too close to a crumbling cliff-top; and an unfortunate few do topple over onto the rocks below. Once they hit the rocks, it's all over.

At the FMA, we will be focused on ensuring that cliff-top path is as stable as possible and that the dangers are visible to all who navigate the path.

The reality is that the path along the cliff top is risky. And not everyone is careful. Companies do fail, and investors do get hurt. Creditors are left unpaid . Employees are exposed and vulnerable. That's the nature of capital markets. Through good market regulation and oversight, we might be able to reduce the chances of this happening, but we cannot prevent it, nor will we. That is not the role of a regulator in a developed market economy, and nor should it be. I reject any assertion that regulators are there to guarantee survival. There will always be an element of risk in securities market participation and this will never change despite all the regulation, close supervision, powers or resources in the world. Risk-taking, in the right circumstances and with the right resources and controls, is appropriate and I encourage it as an enabler of capital growth.

I am not, however, an advocate for the efficient markets theory of minimalist regulation. When a company plummets over that cliff because its directors and management have been asleep at the wheel - or worse, because they've bailed out the door and let their investors take the plunge alone - then we will look to see what action the FMA can take. We will take action.

As a new Crown agency, FMA will consolidate functions currently fragmented across the Securities Commission (which will cease to exist) and part of the Ministry of Economic Development (NEU, SCCU, ISU). It will not assume any functions of the NZX.

Our establishment legislation is the Financial Markets (Regulators and KiwiSaver) Bill, which sets up the FMA as a new financial sector 'umbrella regulator', with enhanced powers of regulation and enforcement including important changes to the governance of KiwiSaver schemes.

At the start of this month, the Commerce Select Committee which considered the Bill establishing the FMA published its report, and subject to the legislation's passage through the House, we are optimistic the FMA will be up and running by May.

In recent years - and here I'm quoting the Minister of Commerce, The Honourable Simon Power, who is overseeing the Bill through Parliament - confidence in the financial sector has been sorely tested by the Global Financial Crisis and further damaged in New Zealand by a number of serious corporate collapses.

In particular, around 60 finance industry companies have gone under or arranged moratoria in the last five years, putting at risk $8.5 billion of investors' money. In the wake of these events, investigations into allegations of false and misleading statements are ongoing, and charges have been laid against a number of directors of finance companies.

Jane Diplock, current chairman of the New Zealand Securities Commission, has suggested these finance company collapses occurred in "a regulatory desert". Given the boundaries of the current legislation, the Securities Commission's role was - and is - limited to ensuring risks were properly disclosed in prospectuses, investment statements and so on, allowing investors to make their own judgements as to whether the returns being offered were worth those risks.

This begs the question: Is disclosure the answer? Are all investors equally competent to understand what issuers tell them? Are all products suitable for the retail market? Should investors enter any market without a basic comprehension of what they are acquiring? What is the role of the regulator in relation to retail investor participation? Does it conflict with our objective to promote market growth? Should regulators leave the wholesale or institutional markets alone?

Regulators can do no more than operate within their legal boundaries and, if these are too limited, they should ask for more powers. I believe the Government has heeded this call with the formation of the FMA and I welcome that commitment.

The Government's key focus now is to restore investor confidence in New Zealand's capital markets. Investor confidence is seen as crucial if New Zealand is to develop the kinds of vibrant capital markets needed to lift our country's economic performance. We also need to be mindful of New Zealand's international reputation as an efficient capital market, and our regulatory structure must reflect that.

The fallout from the GFC, and finance company collapses together with the recommendations of the Capital Development Taskforce delivered in late 2009, made clear the need for a more integrated approach to regulating the financial sector, and strengthening key regulatory agencies' enforcement powers.

Market participants need to be subject to clear rules so that investors can be confident that those rules will be actively and consistently enforced.

Investors also need to be able to easily access relevant information about investing wisely and well.

So you can tell there are high hopes for FMA. There has been almost unanimous support for the creation of FMA through the parliamentary process.

The legislation concerning its establishment has been fast-tracked through the House (since September last year) ahead of the Government's work on the wider review of New Zealand's securities laws.

Fast-tracking will allow FMA to be up and running in time to help implement changes to securities law once the review is completed.

The FMA faces some very significant challenges and I am not underestimating the scale of the task ahead. Only this week some of you may have read the Morningstar second global study of investor experience in 22 countries that rated New Zealand last with a D -! The report said New Zealand scored worst because of its low rating in the key areas of disclosure as well as regulation and taxation. This reinforces some of the points I have been making about the urgent need to improve our disclosure and regulatory regimes.

Morningstar acknowledged New Zealand is moving to improve its performance with the creation of the FMA and the upcoming review of Securities law. What this demonstrates is that the eyes and expectations of the global investment community are on New Zealand and the work of the FMA. And we not only have the major task of restoring investor confidence among New Zealand investors but internationally as well! I welcome that challenge.

As a New Zealander who has been resident in Australia for much of the past 20 years where I have worked in banking and financial markets risk management, enforcement, litigation and public sector management, and most recently for ASIC, the Australian securities regulator, it is pleasing to me that New Zealand is implementing a 'twin peaks' regulatory model similar to the Australian ASIC/APRA design. This model has now been held up as the most effective model to address the flaws in unregulated or thinly regulated markets where the most problematic issues arose in the GFC.

While Australia is our closest trading partner, I'm sure everyone in this room is aware that the two economies are operating at different speeds and with quite different economic drivers.

Both economies have been hit by the GFC and have managed the downturn in different ways. The impact on the regulatory environment is, as I see it, two-fold.

In Australia, it resulted in a reaffirmation of the twin peaks model and a tightening of information sharing and communication through the Council of Financial Regulators representing the Reserve Bank, APRA, ASIC and the Treasury.

In New Zealand, we are now implementing a similar twin peaks model whereby the FMA will sit alongside the Reserve Bank. The Reserve Bank has had its prudential supervisory powers over the banking sector extended to cover the likes of finance companies and credit unions. The Governor of the Reserve Bank and I are determined to ensure the success of this new model.

Although many in this audience may look jealously across the Tasman and may regard Australia's performance as superior, there are also some significant challenges posed by the Australian model which some commentators have criticized as having added unnecessary costs to business.

In particular, directors of Australian companies face both state and federal regulatory obligations in many areas, for instance such as tax and workplace health and safety. These obligations are not always easily comprehensible or consistent. This often involves a lengthy and expensive compliance process and one which New Zealand can happily avoid.

FMA's most significant regulatory relationship outside New Zealand is with ASIC, and there are a range of joint initiatives which the FMA will continue to pursue with ASIC, including the promotion of fundraising on both sides of the Tasman and moves to recognise financial advisors in each country. As our respective Prime Ministers very clearly articulated last month when Australian Prime Minister Julia Gillard visited New Zealand, they desire to see our economies achieve a single economic market. As the financial markets and conduct regulators of our respective economies, FMA and ASIC will undoubtedly play a critical role by helping shape this goal.

FMA's main objective is to promote and facilitate fair, efficient and transparent markets.

FMA will have the Securities Commission's current powers to enforce securities law but it will be backed by a principles-based approach to regulation. It will have an enhanced role in overseeing registered securities exchanges, and be responsible for the regulation of financial advisers, financial service providers, trustees and auditors.

Over the next few weeks, we will be finalising our Statement of Intent and that will be the first opportunity for the new FMA Board to express to Parliament and to all of New Zealand what we propose to do and how we propose to do it.

What I can share with you at this stage are my personal aspirations for FMA.

The first is seamless delivery of services for all stakeholders on and from Day 1.

If you are a customer of FMA or you interact with us on Day 1, you will immediately see a new name and logo from that of the Securities Commission. But this cosmetic change will be reflective of a much deeper organisational and cultural change that will follow in the coming months.

I am not here to dictate how to run New Zealand's capital markets. I will listen, I'll inquire, I'll compare and I'll seek feedback as to the right model and regime that best suits the needs of all New Zealanders: issuers, participants - intermediaries like financial advisers and the NZX - and investors.

While change in the regulatory structure is inevitable and desirable, we must not throw away those parts of the previous model that worked well.

Efficient capital markets are a marriage of well-performing and mature product issuers and advisers, and informed, confident, risk-savvy investors. FMA's objective is to promote both - and you should constantly measure us against that yardstick.

I'm not a believer in regulation for regulation's sake but I'm passionate about effective and proactive regulation.

In order to be effective and proactive, FMA will be outward-looking and reliant on information from the market about where the greatest risks to that marriage between product issuers and investors are.

We will be looking to market participants and their advisers to be our eyes and ears so we can deploy our resources and our arsenal of enforcement tools to best effect.

While one of the core new functions of the FMA will, we hope, be a properly resourced, strategic market intelligence function, we're not an island. We cannot always predict mishaps, nor be on every cliff top to prevent every fall. We will need your input to help us best target our activities.

Finally, while New Zealand is part of the global economy and is increasingly influenced by events, cycles and innovations in our larger trading partners, I will not lose sight of New Zealand's own unique identity.

I have no intention of imposing a foreign model on a reluctant New Zealand economy. Many of you may wonder whether I've been appointed as some advance Australian mole to surreptitiously prepare you for an Australian takeover.

Clearly, we have to be alive to and aware of developments in our closest trading partner, and our regulatory structures must operate effectively together with seamless information-sharing. We should leverage those opportunities to the fullest extent. However, New Zealand's market is different and our regulatory structure, I believe, must reflect those differences.

Over the coming months, I encourage you to reach out and interact directly with the soon-to-be appointed FMA Board and my chairman Simon Allen, with me, and with my new senior executive team to deepen existing relationships, create new opportunities for sharing ideas and intelligence, and to build the trust that we each need to do our jobs well. This will be a partnership we can all be proud of.

I look forward to that journey with you. I encourage you to be part of New Zealand's success.