The most important point to note about the final Capital Markets Development Taskforce report is that it is only the first step in a long process.
The three steps in the process are as follows:
* The taskforce’s recommendations.
* The implementation of these recommendations by the Government.
* Enforcement of the new rules.
New Zealand is world class in terms of stage one as we probably have more taskforces, committees and conferences, on a per capita basis, than any other country.
However when it comes to implementation we rate no more than four out of 10 and as far as enforcement is concerned we would be lucky to rate even one out of 10.
Our capital markets are a perfect example of this. We have had a large number of reports and recommendations, particularly after the 1987 sharemarket crash, but few of them have been implemented.
This is mainly because big business, and especially the Business Roundtable, lobbied effectively against legislation that would have given a big boost to our capital markets by giving greater protection to individual investors.
Our enforcement has also been pathetically poor; in fact it has been almost non-existent.
This is why all eyes are now on Commerce Minister Simon Power because he must drive the taskforce’s recommendations through Cabinet and also make sure there is a strong regulatory body to enforce the new rules and regulations.
This column will scrutinise Power, particularly in terms of stages two and three, over the next few months as we might as well pack up and move our capital markets to Australia if the taskforce’s recommendations are not implemented with haste.
The taskforce has five main recommendations as far as individual investors are concerned. These are;
* There have to be easier to understand investment statements that contain more relevant information.
* Better and more transparent fee disclosure.
* Investors should receive fee-based, rather than commission-based, advice.
* More comprehensive portfolio holdings, particularly by fund managers.
* A centralised database for investors should be established.
The investment statement regime, which was introduced following a recommendation by the Securities Commission, has been a major problem for our capital markets. These investment statements have replaced prospectuses as far as most investors are concerned yet they are not monitored by the commission, they don’t have to be registered at the Companies Office and they are little more than advertising material.
The investment statements of recent failed products contained pictures of a smiling investor lying in a hammock with a glass of wine. They contained almost no relevant information on the product that was being sold to investors.
Improved investment statement disclosure is an absolute priority but who will monitor these documents? The Securities Commission has consistently proved over the past 30 years that it is far too timid and unwilling to act unless given clear instructions from the Government to do so. As financial markets move far more quickly than government ministers and officials, the commission has been hopelessly ineffective as far as enforcement is concerned.
Accurate fee disclosure is also becoming more and more important, particularly since the introduction of the KiwiSaver scheme. There is no standardised fee disclosure regime in New Zealand, with some product providers having a one-off inclusive fee whereas others have a disclosed fee but a large number of additional fees that are also charged against investors.
The external management structure of property entities, both listed and unlisted, is an example of this. It is almost impossible for the ordinary investor to work out the total fee structure of these property entities.
KiwiSaver is also proving to be a problem as far as fees are concerned. Many of the big providers, with a number of different KiwiSaver funds, lump them all together in their financial statements and it is extremely difficult to identify the fees of any individual fund.
A number of unacceptable practices have surfaced, including charging fees by deducting units from investors. These fees are difficult to discover because they are buried in the notes of the accounts. They also falsely boost the net asset value because the costs associated with the fund are taken into account by reducing the number of units held by investors.
The problem is that we have no standardised form of fee disclosure and no regulatory agency with the initiative to monitor them.
One of the biggest problems in New Zealand is that investors don’t want to pay for financial advice so they use financial advisers who receive commissions from product providers instead of charging fees. This practice is as financially hazardous as it would be if doctors did not charge patients and were only paid by the drug companies on the basis of the drugs they prescribed.
Investors will be the major beneficiaries of a move from a commission to a fee-based structure.
The unwillingness of fund managers to disclose their portfolios has been a characteristic of New Zealand’s financial markets for far too long. This reluctance is based on the false perception that competitors will copy them whereas the main objective should be to entice new investors to our financial markets through better disclosure.
This problem would be quickly solved if we had a centralised database where all investment-related product documents – for example prospectuses, investment statements and annual reports – were electronically stored. This website should also have a standardised performance and fee reporting structure with all comparative performance and fee data readily available for investors.
The Securities Commission has been in an ideal position to establish this database but it hasn’t done so.
This brings us to the most important stage of the process, which is stage three. This is the enforcement stage and the role of the Securities Commission.
Enforcement has been a major problem in New Zealand for a long time. This enforcement issue was one of the major deficiencies identified by the Roche Committee’s assessment of our securities markets, which was completed nearly 20 years ago. The report was named after the committee’s chairman Brian Roche, who will become chief executive of New Zealand Post on January 1.
The Securities Commission has been a hopelessly ineffective enforcement agency for a number of reasons including: it does not have any true investor representative; there are too many partners of large law firms on the commission; the commission’s chairman is also its chief executive; it has not had a presence in Auckland where most of the shenanigans have occurred and it has developed a reactive, rather than a proactive, culture.
There was great hope for the commission when Jane Diplock was appointed from ASIC, Australia’s equivalent of the commission, but she has proved to be a major disappointment as the organisation has become more bureaucratic under her regime.
The Capital Markets Development Taskforce recommends that the best regulatory model is one involving the consolidation of the Securities Commission, New Zealand Markets Disciplinary Tribunal and some regulatory functions of the NZX and Companies Office. This is somewhat similar to the recommendations of the Russell Committee 20 years ago. These recommendations were never implemented and investors and our capital markets have been big losers as a result.
This time there won’t be a second chance; our capital markets have contracted sharply over the past two decades, particularly when compared with residential property.
The pressure is now on Commerce Minister Power to push through the implementation of the proposals recommended by the taskforce.
Particular importance should be placed on stage three, the enforcement stage, because regulation that is not enforced can be worse than no regulation at all.
It is important that this regulatory agency is flexible, proactive and not bureaucratic. The design and structure of this agency will be a major challenge for the Commerce Minister.
According to the taskforce there is the potential for long overdue growth in our capital markets if its recommendations are implemented and enforced.