Comment: The Regulators that Roared

People may not go to jail for their actions, but many offering investments crossed a line. Photo / Rotorua Daily Post

You have heard of 'the mouse that roared' and it seems that across the Tasman the regulators have been finding their voices this year. Our cousins in Australia have been busy with regulation though New Zealand has been comparatively mouse-quiet.

Last week, Australia's APRA released its discussion paper on Proposed Extensions to Governance Requirements, hot on the heels of a public disclosure draft of the National Consumer Credit Protection Bill and ASIC's indication it will shortly release a new regime for disclosure of short-selling trades. There's more in the works.

APRA's paper and draft guide on remuneration proposes discouraging golden parachutes for company directors and new draft rules for boards of financial institutions meaning they take direct responsibility for the pay of sales staff, traders, agents and risk personnel, as well as senior executives.

The National Consumer Credit Protection Bill is partly a tidying up of messy and incongruous State legislation and stems from a late 2008 Productivity Commission report. It introduces new licensing rules for lenders and has new concepts including stronger ethical requirements for lenders requiring them to ensure their activities are engaged in efficiently, honesty and fairly.

Notably, the Consumer Credit Bill requires the lender to assess whether the credit contract is unsuitable for the consumer. The onus here may seem insignificant but it requires the lender to consider potential hardship on their client, not just the benefits.

Reasons a credit contract may be unsuitable include the likelihood the consumer will be unable to comply with their financial obligations, can do so only with substantial hardship or the contract does not meet the consumer's objectives.

What has New Zealand been doing? If there are movements afoot the websites of Treasury and the Ministry of Economic Development are a little coy about it. A visit to the Commerce or Securities Commission websites suggest not much more than a preternatural obsession with Telecom on the part of Comcom.

The credit crisis has raised questions about adequacy of regulation. While many American commentators wisely observed that recrimination was neither timely nor appropriate during the economic freefall of last year people began talking about the 'moral risk' of those who caused the bubble and it was clear the time would come to talk about regulation.

If you've been watching the meltdown you may have noticed no regulator or bank in Australia or New Zealand has been delusional enough to state publicly they avoided the pointy end of derivatives or credit crisis solely because of prudent management, good ethics or adequate regulation. Given how off-guard the world was caught when the derivatives bubble burst, NZ traders and banks might well have been thinking 'chance would be a fine thing' during the noughties.

Accident of size may have saved us from drowning in derivatives but that doesn't mean New Zealand shouldn't review our possible exposures and take prudent steps to replicate Australian initiatives. It isn't just big countries that feel the impact of ineffectual regulation. Consider that many attribute the (necessary) floating of the dollar in 1985 and sudden market and forex liquidity to part of the reason why NZ felt the 1987 crash disproportionately hard.

The disaster in Iceland was partly caused by high interest rates and inadequate regulatory controls over currency which kept the krona strong allowing the locals to borrow offshore with too much hidden risk.

Steven Davidoff, in the New York Times 'Deal Book' advocates US regulators should be consolidated into three: a financial markets regulator, bank capital regulator and systemic risk regulator. While the system is not an exact fit to our needs, the idea that regulators should be less tied to statutory stricture and have more fluid boundaries is an interesting one.

If you think the author is advocating much more regulation, think again. Regulators shouldn't suffocate the market with unnecessary stricture. Realistically, Government cannot impose ethics by regulation. Legislation is ham-fisted dealing with such things and can stifle legitimate entrepreneurial risk taking - something we don't even encourage enough.

It is always the case that borrowing and investing is about risk. That is true in any age, cycle, bubble or bust. But too often and too starkly we are seeing moral risk in the business pages of our news where people advancing credit or offering investment failed to distinguish between that which does not compromise the letter of the law and that which is unethical. They may not go to jail for their actions but they crossed a line that causes harm.

The balancing act Australian regulators seem to deal with is the relative risk and the relative knowledge of the parties in investments. Also, where business people ignored moral risk in business to the advantage of their personal coffers. This is where the legislation has been inflexible and slow to respond to date.

It may be the regulators and authorities find New Zealand is not at risk. They may conclude their powers are adequate. But our regulators need to satisfy themselves of two things. In light of the glaring inadequacies and new initiatives in other jurisdictions, is New Zealand's regulatory framework sufficiently robust to protect us? If not, what recommendations need to be considered?

Simon Arcus is a lawyer who has lived in Sydney and Auckland