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Company controls no substitute for scepticism

KPMG New Zealand December 4, 2007

For use after noon, December 4, 2007

Tighter finance company controls no substitute for healthy scepticism

Tighter controls on finance companies cannot relieve investors of responsibility for understanding the investment they are contemplating or maintaining a healthy level of scepticism, KPMG’s latest survey of the sector finds.

The firm’s Financial Services Deputy Chairman Godfrey Boyce says tighter controls are a logical reaction to the failure of 13 finance companies over the past two years.

“Eighteen months ago, in anticipation of a shake-out in the industry, we advocated stricter supervision, including the introduction of a mandatory credit rating system,” he said.

“That has come to pass – although it is still to be implemented – but it shouldn’t be regarded as a panacea for the industry’s ills and nor should it be allowed to encourage investors to abdicate their responsibilities.

“In many cases, the information provided by the companies that failed, offered enough information to provide an appreciation of the key issues facing those companies.

“Burned investors subsequently argued the information was too complex for them to understand or they trusted third party advisers. Their comments underline the need for greater education to ensure that they understand the information they are being given and are able to make an informed choice.

“The crisis in the industry showed that not only did many investors not understand the assets their money was funding but some were oblivious to the danger arising out of putting all their eggs in the same basket.”

Mr Boyce said the new regulatory regime based on mandatory credit ratings must take steps to educate New Zealand investors on those ratings. Discussions with the industry indicated the majority of unrated companies are concerned that without a balanced education programme, companies with a BB or B credit rating will be shunned simply on the basis of not being “investment grade”.

“A rating system that is poorly understood runs the risk of doing more harm than good.

“The industry is responding and engaging with the credit rating agencies – now the government agencies need to respond in terms of investor education.”

KPMG also raised concerns about the complexity of investment statements.

“More educated investors won’t be enough if the information going to investors isn’t significantly improved. In practice, investment statements have become increasingly compliance based, sometimes amounting to more than 70 pages.

“The documents are not user-friendly and are rarely read, or they require professional advice from intermediaries. You can’t see the wood for the trees.

“We support the case for the development of new standards for transparent, plain language and user-friendly documents. We think the Reserve Bank is on the right track with a six monthly Key Information Summary but there is a case for going further.

“The Australian regulators have a disclosure regime where non-compliance with set industry benchmarks has to be explained - an ‘if not why not?’ requirement. The explanations provided might be more telling than any other measure.”

KPMG advised investors to extend their scepticism to financial advisers. Mr Boyce said events had demonstrated that many advisers had limited understanding of the industry and how a company was performing.


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