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Dalziel: 4th Annual Securities Law Update

27 August 2008 Speech Notes

4th Annual Securities Law Update

Ministerial Address by Commerce Minister Lianne Dalziel to the 4th Annual Securities Law Update
Wellington Town Hall

Good morning. Thank you for inviting me to speak to you today. I have to say, that when I looked through your programme I felt a certain sense of achievement. The topics you're discussing at this Update represent a significant amount of the work the government has been driving since first elected in 1999. I am pleased not only with the volume of work we've managed to get through, but also the quality of the improvements we've made to various regulatory frameworks. This is especially so when you consider the very low base from which we began our reforms. Not only have we been undertaking this work, we have also been looking to improve the overall quality of regulations and the regulation-making process itself.

The current economic climate may not be best light in which to fully appreciate those improvements. I know that the global credit crunch is having impacts even in our small and somewhat remote economy and that investor confidence has been badly shaken by the raft of recent finance company failures. But I'm confident the changes we have put in place and those which we are continuing to drive through, have – and will – better prepare New Zealand and New Zealanders to weather these somewhat uncertain times.

Most of you will have often heard me run through the list of our major accomplishments – we inherited a Takeovers Panel but no code for it to enforce, and thus no internationally accepted standard for protecting minority shareholders in a takeover situation. We fixed that.
We passed the Securities Markets legislation which introduced a co-regulatory framework for supervising registered exchanges. Then we introduced continuous disclosure obligations; followed by strengthened rules relating to insider trading and market manipulation; and we beefed up disclosure requirements for Investment Advisers. Now we're registering financial service providers, introducing occupational regulation for financial advisers, and adding prudential supervision of non-bank deposit takers to the role of the Reserve Bank.

There have been criticisms made of the order of work that we chose to undertake but I stand by it. We couldn't have got as far as we have without first addressing concerns in the capital markets environment. Reform of securities markets law was a vital step to ensuring New Zealand's markets are attractive to both domestic and overseas investors, as well as cost-effective for local and international firms. In comparison to other nations New Zealand was largely lacking regulatory controls in the markets. Regulatory reform was needed to build up confidence in the markets.

I know, for instance, that without sorting out these issues first, the Securities Commission could not have done the work that resulted in the $27m settlement of insider trading proceedings, without admission of liability of course, for the shareholders of Tranzrail.

I understand that Caroline Ramsey from the Ministry of Economic Development has given you some of the history and context for the Review of Financial Products and Providers as well as outlining the future policy agenda so I won't go into that in too much detail. But I do want to emphasise that our aim from the very beginning was to take a holistic approach to reviewing the sector so we could look at the various interdependencies that exist in the industry and develop proposals that accounted for these interconnections.

I believe that this has fundamentally improved our understanding of the sector and has enabled us to develop rules that are more suited to the realities of what is a complex financial environment.
Today I want to clarify some of the detail of the legislation arising out of that review: the Financial Advisers Bill, the Financial Service Providers (Registration and Dispute Resolution) Bill and the Reserve Bank Amendment (No3). The last of these had its second reading last night and received cross party support, which is very positive. That is the Bill that brings non-bank deposit takers under the prudential supervision of the Reserve Bank, which will mean obligatory credit ratings, along with various capital adequacy requirements that are appropriate for this sector and a "fit and proper" test for those seeking to run such organisations. The Financial Service Providers (Registration and Dispute Resolution) Bill provides for the registration of all financial service providers to allow for negative assurance in terms of who can register and it requires all such providers to have access to approved consumer dispute resolution services. This aspect of the law will transf
er to the Minister of Consumer Affairs in line with the role she already plays with various consumer codes of practice.

The Bill I want to spend my time on today is the Financial Advisers Bill largely because recent debates around it have generated a lot more heat than light. The Finance & Expenditure Select Committee's second interim report unfortunately does not contain a lot of detail, so I have decided to use today's address to put some flesh on the bones by discussing the government's view of the way forward.

I am aware now that at least two of the professional bodies who represent financial advisers, and who had had aspirations of being an Approved Professional Body under the original co-regulatory regime, want the process to slow down now that major changes have been proposed to the Bill. I don't believe we should slow down. If we can get the Bill through before the election, we should and I will explain why. What little confidence remains in financial advisers and in finance companies diminishes further with each announcement of failure. Everything we do is too late for those who have already lost money, but the longer it takes for the law to pass, the greater the timetable for implementation and the longer the wait for confidence to be restored to the sector.

When we decided that we would shift from a co-regulatory model to the single oversight of the Securities Commission, we essentially knocked two years off the implementation date – 2012 to 2010.

The investing public has no idea why these things take such a long time, but as you would have heard from Caroline, there is a considerable amount of consultation and testing of views that needs to occur before new regulatory frameworks are put in place.

And the Act is only the first step, which is why I want it in place, so the detailed work can be begun by the Securities Commission. I noticed someone saying recently that there was nothing to stop the Securities Commission having some input into the form and structure of the new model without the law being passed, whereas I am sure everyone here knows the Securities Commission cannot do anything until it has a legal mandate to do so. It cannot set up the working groups with industry representatives to start devising the process for developing codes of conduct and requirements for authorisation until the Act is passed. And that is why I think we should pass it if we can. Officials can then make good use of the election campaign 'down time' to consult with industry on the practicalities and the all-important detail. I don't think we should waste up to 6 months if we can avoid it.

I think that it is worth remembering that for every call for restraint from the sector there are dozens of investor voices clamouring for changes to be made – and the sooner the better. I heard one representative of one of the finance advisory bodies suggest that the client wasn't interested in the regulation of financial advisers – I think I should re-direct my mail to him, because for every one of those who knows the legal framework isn't there are dozens who thought it was.

I won't traverse the ground that Caroline has covered, but as I said before the Bill as it was introduced proposed a co-regulatory model for the regulation of financial advisers, where industry-based approved professional bodies would work with the Securities Commission to regulate financial advisers.
This was designed to ensure effective regulation of advisers, while recognising and drawing off the vast knowledge and expertise that exists in the market.

It became very clear to me late last year that such a model would not work in practice. However, it wasn't until April that the Select Committee agreed to consult publicly on a model in which the Securities Commission would be the central supervisor. The loss of industry expertise in this model was a concern to me and so a number of proposals have been put forward to ensure that industry continues to be involved.

The proposal now is to establish a Commissioner of Financial Advisers who would be a member of the Securities Commission. The Commissioner would work with industry to develop a code of conduct and to establish appropriate disciplinary processes. I am confident that this approach will ensure that we have the strength of central supervision and the experience and knowledge of industry participants.

The industry has made it clear through the submission process that it wants consideration given to the complexity of the product on offer and the risk involved to the investor. It is clear that the risk associated with the range of financial advice in the industry differs. The proposed tiered approach to regulation of financial advisers will mean the obligations on advisers will be tailored to the risks associated with the financial advice given.

Consumers are fairly easily able to switch between simple securities such as insurance products, credit products or bank terms deposits without incurring significant losses. Problems are more likely to arise with more complex securities or investment and savings planning and for that reason the Select Committee is now proposing that anyone giving financial advice on such products (which will be Category 1 products) – whether they are working independently or are employed by a financial service provider – will need to be individually authorised by the Securities Commission.

This will ensure that these people have the level of expertise and knowledge, as well as accountability, necessary for advising on investments which may require consumers to put on the on the line large sums of their hard earned cash or which could affect their future savings.

The Securities Commission will also be given the power to certify financial institutions which meet the standards established by the Commission in consultation with the industry. Certified Financial Institutions would then be responsible for financial advice offered by their staff on simple products.

This is intended to cover bank tellers and insurance sales staff and agents, who are selling basic products offered by the bank, insurance company, credit union or other financial institution and where the advice given poses low risk to the consumer.

Under these proposals authorised financial advisers (selling complex Category 1 products) employed by a Certified Financial Institution would still have to meet their individual obligations, as they would have to be individually authorised by the Commission. This means a level playing field from the consumers' perspective.

By adopting a tiered approach to the obligations for financial advisers, narrowing the application of the Bill, and allowing for institutional certification we will have ensured that the regulation is effectively targeted where the mischief in the financial advisory industry exists.

Hindsight is a marvellous thing and, while I wish I had been alert to the need to pull back from the co-regulatory framework we approved at the beginning of 2006, several months before the first of the finance company failures began and nearly 18 months before the Bridgecorp failure, I don't believe it would have made any difference.

In every speech I have given on this subject I have emphasised the crucial importance of lifting financial literacy across New Zealand.
Disclosure means little if you don't know what the point of comparison is – for example how do you know your adviser is potentially influenced by the amount of commission, if you don't know what he or she would receive for another product? How do you know that a B credit rating by some rating agencies represents junk, when Cs were good enough to pass your school certificate? How do you know that a product is under-priced when you don't know the level of risk you are taking with your hard-earned money?

One of the frustrating aspects of being the Minister of Commerce when there is a series of collapses such as the one we are experiencing, is trying to explain that inexperienced investors going in, will be equally inexperienced going out.

The regulation of financial advisers is one part of the solution, but it is not the only part. The other parts are education, education and education. Financial advisers already have a number of professional bodies they can join. All of them focus on ethics, standards, qualifications and experience; most have disciplinary processes to hold their members accountable. Some have such a high entry bar that the threat of being struck off is enough. While there is currently no legal requirement for financial advisers to be authorised, inexperienced investors should only take advice from someone who is a member of such a body.

We must remain focused on lifting New Zealand's level of financial literacy. While we may have made some progress in the realm of financial education, both the ANZ-Retirement Commission Financial Knowledge Survey in 2006, and the Reserve Bank's survey on the understanding of financial information in 2007 found that the level of financial literacy in New Zealand still falls well short of where it should be.

As many of you will know the government has launched a financial literacy campaign spearheaded by the Retirement Commissioner, who has finalised a National Strategy for Financial Literacy. The strategy recognises that there are many public and private sector players in this important space contributing to these shared objectives.
They range from schools that deliver on the curriculum, which as you know has been modernised and updated to ensure that financial literacy is addressed, through to the NZ Enterprise Trust taking real business experiences into the school environment, through to the Securities Commission teaching the basics of risk and return to any age group – just to name a few.

So in conclusion, the legislation is being put in place and there is considerable effort being taken by a wide range of groups to improve the country's levels of financial literacy, but it will take some time for confidence to be restored.

On that note, thank you for the opportunity to say a few words and I would be happy to address any questions you may have.


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