Gareth Morgan: Misuse of capital markets must end

Capital Markets Development Taskforce member Gareth Morgan (left), pictured with Adrian Orr, says transparency of purpose is vital for a market to function fairly and efficiently. Picture / Mark Mitchell

The release of the Capital Markets Development Taskforce (CMDT) report, together with the work of the Tax Working Group and the 2025 Taskforce, will provide ministers with plenty to ponder over their Christmas break, as a forerunner to what promises to be an action-packed 2010 on the policy front.

CMDT was established in recognition that capital markets play a vital role in economic activity, that their allocation of capital is critical to maximising incomes and jobs, ensuring an efficient economy that exhibits strong productivity results, and that savers, investors and consumers make decisions that are not just best for them but vitally, best for overall economic performance.

It is this last aspect that CMDT focused on, in light of the calamitous outcomes and shameful behaviour from some in our financial markets.

New Zealand's economic well-being has long suffered from a gross over-investment in property - inspired primarily by strong bias in Reserve Bank rules that incentivise banks to prioritise mortgage lending over all other forms, and supported by inappropriate tax loopholes for that asset class.

Then the global credit crunch descended. Devastated savers and investors are the human face of the cost such policy inadequacy has imposed. Finance companies that funded the worst of the property sector excesses have in the main, vaporised.

The cost to the economy of this obscene misallocation of capital is reflected in our ongoing slide down the OECD league tables and its ramifications highlighted forcefully in Treasury's recent Long Term Fiscal Projections.

For its part, CMDT has concentrated on measures to improve the trust, safety and safekeeping of investors' money as they re-enter capital markets after the storm, to incentivise providers to earn investors' trust through greater transparency and accountability, to increase the volume of high quality local offerings, and to strengthen enforcement of these values.

Investor care takes a prime place in the report. Recommendations support and extend measures already in train to both improve the standard of conduct of providers, trustees, and advisers as well as align their objectives with those of individual investors whose money they are guardians of.

By emphasising the fiduciary duty to the individual investor the recommendations redress the imbalance of market power. The confidence of mums, dads and communities in the conduct of capital market providers, trustees and advisers is critical to resurrecting our capital markets.

Much work on the standards expected from advisers has already been done, but amongst its recommendations CMDT recommends that commission salespeople cannot call themselves independent advisers as it is simply a lie. Transparency of purpose is essential for any market to function fairly and efficiently.

As far as product providers and trusts are concerned, CMDT does not accept self-regulation nor disclosure as being a sufficient condition to protect investors from inappropriate conduct. To that end, it's recommended that the fiduciary duty of care providers have to those who purchase their product be made more explicit, be reaffirmed annually and mechanisms established to ease investors' right of redress.

Regarding the obligations of trustees, both professional trustee companies and other trustees (many of whom are inexpert on matters of investment) appointed to schemes which care for the funds of New Zealanders, need to be substantially strengthened.

When people hand over care of their property to unit trusts, superannuation funds and other trust arrangements they expect a duty of care from trustees. This fiduciary duty must be from each individual trustee to each individual investor that should definitely not, without prior notice and confirmation, be subjugated to some perpetual interest of the fund as a whole.

The long-term performance of local superannuation funds, has not even matched market averages, evidencing the current trustee model has failed. To improve outcomes for investors, it is recommended competition be introduced to those areas where trust arrangements have undue regulatory protection, so individual members in long-term savings schemes have more choice.

The calamity with the ING/ANZ Diversified Yield Fund showed some investors getting better treatment than others, highlighting the weakness in the trustee model.

All in all the CMDT has focussed on just part of the puzzle in putting Humpty together again after a succession of slips in economic policy.

Sure, economic performance will suffer so long as our capital markets misallocate capital. But meaningful tax and benefit reform also remains elusive and making marginal changes in that arena is to fiddle while Rome carries on.

But most importantly, and as the PM has noted, even economies with substantial taxes on property still suffered from the property excesses.

So long as banks are encouraged by their central banks to favour mortgage lending over all other forms, the barrier to better sustainable economic performance remains formidable. The one taskforce missing in 2009 was one on our Reserve Bank's management of prudential supervision.

Gareth Morgan is a director of Gareth Morgan Investments. www.garethmorgan.com