Wanted: Guarantee for investors

By BRIAN GAYNOR


Several important lessons regarding leadership, fidelity funds and investor protection have been learned from the Access Brokerage collapse.

When Bill Garlick told the New Zealand Exchange late on September 3 that his broking firm had serious problems, the immediate response of NZX chief executive Mark Weldon was to take a strong leadership role. Representatives of Ferrier Hodgson were on the first flight from Auckland on Saturday morning and the exchange and insolvency experts spent the weekend trying to come to grips with Access' problems.

At 8.34am on Monday, September 6, the NZX announced that Access Brokerage had been suspended from trading, effective immediately, and the matter had been referred to all relevant authorities including the Securities Commission and Serious Fraud Office.

The announcement from Weldon contained the following paragraph: "NZX considers it is vitally important that the confidence and integrity of the market is maintained. NZX will endeavour to ensure that the obligations that Access has to affected clients are honoured for any trades that have occurred on NZX markets during the period concerned. Options available to the NZX include managing the use of the Fidelity Guarantee Fund, pursuing legal action against those responsible, or using NZX's own funds - despite NZX having no legal obligation to do so."

But some NZX shareholders, particularly 8 per cent holder Forsyth Barr, were opposed to the suggestion that the exchange might use its own funds to reimburse the failed broker's clients.

Under the old regime, the exchange would have done virtually nothing. It would have adopted a passive role and left the receiver or liquidator to look after the Access clients. Weldon's leadership had a big influence on the quick resolution of the Access Brokerage debacle. He went on the front foot regarding client funds and put pressure on the Bank of New Zealand to meet its obligations in relation to the client trust account and the controversial call account.

It is extremely doubtful that the BNZ would have agreed to meet Access Brokerage's client obligations if the NZX had taken a passive role and had not offered to use the fidelity fund or its own money to partially fund the shortfall.

The beauty as far as the NZX is concerned is that the BNZ will now take a leading role in managing and funding the legal action against the individuals it believes to be responsible for Access' collapse.

Do Forsyth Barr and the other complaining major shareholders really want the NZX to return to its leaderless, passive and totally unimaginative strategies of the 1980s and 1990s?

The NZX has a Fidelity Guarantee Fund to help clients of a failed broker. The fund's liability is limited to $500,000 for any single failure or a greater amount as the board may determine. The maximum amount payable to any one claimant is $20,000, or more on the board's say-so.

The NZX fidelity fund has always been relatively small. Twenty years ago, it was worth $568,000, but it rose to a peak of $2.85 million in September 1989. This was achieved through members' contributions and high investment returns.

The fund was hit with claims of $713,000 in the June 1990 year - mainly Buttle & Co - and $1,388,000 in the June 1992 year, mostly due to payouts in relation to the failed Napier broker Wall and Associates and Ararimu Partners and Greville & Co in Auckland.

The exchange stopped levying members in the early 1990s and the fund had shrunk to just under $450,000 when Weldon joined the NZX in mid-2002.

The Australian Government established the National Guarantee Fund (NGF) when the six state stock exchanges merged in 1987. Then, the NGF was worth A$60.4 million ($64.2 million) and it now has available funds of A$164.4 million.

The NGF is available to meet claims arising from dealings with ASX firms. The claims provisions of the NGF are set out under the Corporate Regulations 2001.

The NZX's Fidelity Guarantee Fund, which stands at $460,000, will be stripped bare after being used - in conjunction with the BNZ - to meet the obligations to Access Brokerage's clients.

Until recently, the NZX board could levy NZX firms up to a combined total of $1 million, but this cap has been removed and the board now has unlimited ability to levy its participant companies.

If Forsyth Barr and the other major NZX shareholders are genuinely concerned about the financial strength of the exchange and its ability to protect investors and maintain confidence in the sharemarket, they should lobby NZX directors to levy participating companies in order to rebuild the Fidelity Guarantee Fund.

But the issue of investor protection goes deeper than the NZX and its Fidelity Guarantee Fund.

Most countries have government-initiated fidelity funds and deposit insurance schemes. The National Guarantee Fund in Australia is a good example of a well-funded fidelity fund that protects sharemarket investors.

There is also a wide range of deposit insurance schemes that protect depositors if a bank or financial institution fails.

* Canada Deposit Insurance safeguards all retail deposits up to C$60,000 ($70,000).

* The Danish Guarantee Fund for depositors and investors protects all deposits at banks, mortgage banks and investment companies up to DKK300,000 ($74,000).

* Korea Deposit Insurance defends all deposits at financial institutions up to KRW50 million ($66,000).

* A government-legislated scheme in Spain covers all bank deposits up to €20,000 ($37,000).

* The Financial Services Compensation Scheme in Britain safeguards deposits at all authorised institutions on the basis of 100 per cent for the first £2000 and 90 per cent of the next £33,000, up to a maximum compensation of £31,700 ($85,000).

* US Federal Deposit Insurance provides protection on all deposits up to US$100,000 ($150,000).

These are just a sample. According to the International Association of Deposit Insurers, at least 45 countries have deposit protection schemes, mostly government-initiated.

New Zealand is a major exception. We have no deposit insurance and the stock exchange's fidelity fund has been run down.

Investors and depositors are at the mercy of receivers and liquidators if financial institutions go bust in this country.

(We have a government-initiated scheme - the ACC - that looks after individuals when they are injured, but no depositor protection, whereas in most countries it is the other way around.)

The big risk in New Zealand is the non-bank financial sector, particularly finance companies. Reserve Bank figures show non-bank financial deposits have increased from $6.2 billion to $13.2 billion in the four years to December 31 last.

The non-bank financial sector is almost totally unregulated, there is no deposit insurance and a high proportion of finance company loans are to the high-risk consumer and property sectors.

Investors should be extremely careful when investing in small and unproven finance companies because there will be failures in this area.

When a finance company fails, there will be no deposit insurance and, more importantly, no Mark Weldon to fight their corner.

Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.