New Zealand: Financial System Stability Assessment, including Reports on the Observance of Standards and Codes on: Monetary and Financial Policy Transparency, Banking Supervision, Securities Regulation; IMF Country Report 04/126; April 8, 2004.

IMF Country Report No. 04/126

New Zealand: Financial System Stability Assessment,

including Reports on the Observance of Standards and Codes on

the following topics: Monetary and Financial Policy Transparency,

Banking Supervision, and Securities Regulation

This Financial System Stability Assessment on New Zealand was prepared by a staff team of the

International Monetary Fund as background documentation for the periodic consultation with the

member country. It is based on the information available at the time it was completed on April 8, 2004.

The views expressed in this document are those of the staff team and do not necessarily reflect the

views of the government of New Zealand or the Executive Board of the IMF.

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International Monetary Fund

Washington, D.C.

INTERNATIONAL MONETARY FUND

NEW ZEALAND

Financial System Stability Assessment

Prepared by the Monetary and Financial Systems and Asia Pacific Departments

Approved by Tomás J. T. Baliño and Daniel Citrin

April 8, 2004

This Financial System Stability Assessment is based primarily on work undertaken during a visit to New Zealand

and Australia from October 30 to November 18, 2003. The mission comprised Anne-Marie Gulde-Wolf (mission

chief), Paul Kupiec (deputy mission chief), Barbara Baldwin, Matthew Jones, Jodi Scarlata, Antonio Garcia

Pascual, and Charmane Ahmed (all IMF/MFD); Abdelhak Senhadji (IMF/APD); Michael Ainley (banking

supervision expert, U.K. FSA), Janet Holmes (securities expert, Ontario Securities Commission), and Barry Topf

(foreign exchange expert, Bank of Israel). The main findings of the mission are:

• New Zealand has a profitable and well-functioning financial system, operating in a framework of well-

developed financial markets. Short-term risks to stability appear low, given the favorable macroeconomic

outlook, and sound and transparent financial policies. Stress tests for systemically important banks show

resilience consistent with the sector’s relatively high levels of capital and profits. Dynamic stress tests

involving shocks to agriculture and to external funding show more persistent effects on bank profits, but do not

raise systemic concerns.

• New Zealand’s approach to banking regulation is based on disclosure and market discipline, and employs

limited prudential requirements. The sole supervisory objective is to ensure systemic stability. Given the high

share of foreign ownership, home-country supervision may also act as an additional discipline on bank

behavior. Notwithstanding the clear strength of the present framework, the Reserve Bank of New Zealand

(RBNZ) would benefit from increased real-time knowledge of potential stress in the banking system.

• The absence of a depositor-protection mandate, along with the foreign ownership of all systemically important

banks, would pose unique challenges to the RBNZ if a financial crisis were to occur. The high level of

Australian bank ownership suggests that the successful management of systemic challenges will also require

close cooperation with the Australian authorities. The RBNZ has been reviewing possible crisis management

options and has intensified trans-Tasman cooperation in banking regulation and failure management.

• Recent reforms in securities regulation and the restructuring of the New Zealand Stock Exchange (NZX) have

strengthened the securities regulatory framework. To fully implement the IOSCO Principles would require:

(i) a stronger regime for prevention and detection of market abuse; (ii) a more robust supervisory regime for

market intermediaries and collective investment schemes; (iii) improvements to the disclosure regime for

issuers; and (iv) stronger public oversight of private sector monitors.

The mission members drafted this report.

FSAPs are designed to assess the stability of the financial system as a whole and not that of individual

institutions. They have been developed to help countries identify and remedy weaknesses in their financial sector

structure, thereby enhancing resilience to macroeconomic shocks and cross-border contagion. FSAPs do not

cover risks specific to individual institutions, such as asset quality, operational or legal risks, or fraud.

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Contents Page

Glossary .....................................................................................................................................4

I. Executive Summary and Overall Stability Assessment .........................................................5

II. Macroeconomic, Financial Sector, and Regulatory Context.................................................7

A. Macroeconomic Background ....................................................................................7

B. Financial Sector Context ...........................................................................................7

C. Supervision and Regulation ....................................................................................14

III. Short-Term Stability Issues................................................................................................16

A. Stress Testing the Financial System........................................................................16

B. Nonbank Financial Institutions ...............................................................................20

C. Foreign Currency Exposure and Functioning of Exchange Markets ......................21

D. Money and Bond Markets.......................................................................................22

E. Systemic Liquidity Provision ..................................................................................23

IV. Medium-Term and Structural Issues .................................................................................24

A. Banking Supervision...............................................................................................24

B. Crisis Management..................................................................................................25

C. Cooperation with Australia .....................................................................................26

Tables

1. Principal Recommendations ..................................................................................................6

2. New Zealand: Selected Macroeconomic Indicators, 1999–2003 ..........................................8

3. New Zealand: Financial Soundness Indicators, 1999–2003..................................................9

4. New Zealand: Financial System Structure, 2000–02...........................................................11

5. Sensitivity Stress-Test Scenarios .........................................................................................18

6. Market Risk Results.............................................................................................................18

7. Credit Risk Results ..............................................................................................................19

8. Model Assumptions .............................................................................................................19

Figures

1. Foot and Mouth Disease Scenario .......................................................................................20

2. Funding Shock Stress Scenario............................................................................................20

Annexes

I. Observance of Financial Sector Standards and Codes—Summary Assessments ................28

Annex Tables

1. Recommended Action Plan to Improve Observance

the Basel Core Principles.............32

2. Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code

PracticesMonetary Policy ............................................................................................36

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3. Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code

PracticesBanking Supervision .....................................................................................38

4. Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code

PracticesSecurities Regulation.....................................................................................41

5. Recommended Action Plan to Improve Observance of the IOSCO Principles...................44

GLOSSARY

APG Asia Pacific Group on Money Laundering

APRA Australian Prudential Regulatory Authority

ASRB Accounting Standards Review Board

BCP Basel Core Principles

CAR capital adequacy ratios

CIS collective investment schemes

ESAS Exchange Settlement Account System

FATF Financial Action Task Force

FSA Financial Services Authority

FSAP Financial Sector Assessment Program

GAAP Generally Accepted Accounting Principles

IAS International Accounting Standards

ICANZ Institute of Chartered Accountants of New Zealand

IOSCO International Organization of Securities Commissions

LoLR Lender-of-last Resort

MED Ministry of Economic Development

MFP Code IMF Code of Good Practices on Transparency in Monetary

and Financial Policies

MOU Memorandum of understanding

NBFI Nonbank financial institutions

NZD New Zealand Dollar

NZFOE New Zealand Futures and Options Exchange

NZX New Zealand Stock Exchange Limited and/or New Zealand

Stock Exchange (as appropriate)

OCR official Cash Rate

PTA Policy Targets Agreement

OMO open market operations

RBNZ Reserve Bank of New Zealand

RC Registrar of Companies

ROSCs Report on the Observance of Standards and Codes

SC Securities Commission

SDDS Special Data Dissemination Standard

SFE Sydney Futures Exchange

SRO Self-regulatory organization

TP Takeover Panel

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I. EXECUTIVE SUMMARY AND OVERALL STABILITY ASSESSMENT

1. The New Zealand financial sector is dominated by institutions that are based in

Australia. Supervisory practices are based on a liberal disclosure-based regime, with

limited supervisory intervention. The low savings rate creates a large dependency on

foreign funding. In the absence of appropriate controls, these structural features have the

potential to engender vulnerabilities.

2. The favorable macroeconomic outlook, the profitable and well-functioning

financial system, and overall sound and transparent financial policies mitigate the

aforementioned vulnerabilities, and make short-term risks appear low. New Zealand’s

large net foreign indebtedness position owes entirely to private sector borrowings. Its strong

sovereign rating reflects prudent fiscal policies and no net foreign-currency debt. The

strength of the financial system reduces concerns about the lack of an active supervisory

framework. In the medium and longer run, supervisory enhancements are recommended to

ensure that an adequate framework to monitor and support financial stability remains in

place.

3. The mission’s main findings can be summarized as follows:

• The five foreign-owned banks that dominate the financial system are profitable and

well capitalized. For these institutions, the discipline of New Zealand’s market-based

disclosure regime is supplemented by active home country supervision.

• The foreign exchange market has allowed the private sector to manage its foreign

exchange risks and secure cover from a diverse set of counterparties under a wide

range of market conditions. Foreign exchange hedging is widespread.

• Stress tests show resilience in the banking sector, consistent with the sector’s high

levels of capital and profits. Significant exchange rate swings and house price

declines could be absorbed by all big banks. Dynamic stress test scenarios involving

shocks to agriculture and to external funding costs show more persistent effects on

bank profits, but do not raise systemic concerns.

• Banking supervision is based on disclosure and market discipline, with the sole

objective of ensuring systemic stability. The supervisory regime employs limited

prudential requirements, with no active on-site role for supervisors. The benefits of

this regime include low compliance costs, greater flexibility for financial institutions,

an enhanced role for market discipline, and reduced moral hazard risks. The ongoing

strength of the financial system has reduced concerns about the lack of an active

supervisory component.

• The absence of a depositor-protection mandate, along with the foreign ownership of

all systemically important banks may pose unique challenges for the RBNZ if a

financial crisis were to occur. Outsourcing of New Zealand bank operating systems to

parent institutions and Australian depositor preference law may complicate crisis

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management. These risks have been recognized and control measures are being

analyzed. Efforts underway to improve cooperation with the Australian authorities are

welcome.

• Nonbank financial institutions (NBFIs), while not systemically important, are also

profitable. Overseas regulators provide additional supervision for a handful of the

largest nonbank institutions, which account for around half of the assets of the sector.

• Securities markets are relatively small, with trading and ownership concentrated

offshore. Restructuring of the New Zealand Stock Exchange (NZX) and reforms in

regulation have strengthened the regulatory framework, but some gaps remain that

may delay early detection and enforcement actions against improper conduct.

Table 1. Principal Recommendations

Issue Recommendation

Disclosure-based regime Maintain the quality, scope, and timeliness of disclosure to

ensure it continues to meet best international practice.

Importance of independent

directors

Fit-and-proper criteria should continue to apply in a

comprehensive manner. The RBNZ could offer independent

bank directors the possibility of discussing areas of concerns

without absolving directors of their statutory responsibilities.

Surveillance For banks, monitor more regularly liquidity and large exposure

early warning indicators. Consider commissioning third-party

reports and establish a small specialist team to make focused,

on-site visits on particular aspects of credit and operational risk.

Bank resolution and crisis

management

Review possible approaches to bank resolution, and the

operational and legal consequences that might arise, with a

view to establishing internal operational guidelines.

Nonbank supervision Review practices and resource needs for the government

agencies involved in oversight, especially the offices of the

Registrar and the Government Actuary, with a view towards

enhancing public access to timely and comprehensive data.

Securities markets regulation Enhance regulatory framework by including minimum

standards of conduct for collective investment scheme

operators, improving reporting mechanisms, strengthening

standards and penalties relating to market abuse, and

strengthening oversight of market intermediaries that are not

exchange members.

More specific suggestions are discussed at the appropriate places in the main body of the

report and in the standards assessments.

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II. MACROECONOMIC, FINANCIAL SECTOR, AND REGULATORY CONTEXT

A. Macroeconomic Background

4. New Zealand has a resilient macroeconomic framework, benefiting from a series

of reforms undertaken over the past 20 years. Key features include a floating exchange

rate, deregulated financial markets, far-reaching privatization, a sound and transparent

medium-term framework, and an inflation-targeting framework under an independent central

bank. These factors, combined with favorable economic conditions, have underpinned New

Zealand’s strong real GDP growth rate of nearly four percent per annum since 1999.

5. Within the above framework, New Zealand has, in the recent past, seen

significant capital inflows to compensate for persistent low savings rates. The country

has accumulated a relatively high level of foreign debt, and gross debt now exceeds

100 percent of GDP, with the bulk of this being owed by the private sector. Given the

conservative fiscal stance, foreign capital inflows are matched by high private sector

borrowing from the banking sector. The strong sovereign rating reflects prudent fiscal

policies and no net foreign currency debt by the public sector.

6. Recent macroeconomic conditions have been favorable, even though the

continuing appreciation of the New Zealand Dollar (NZD) may dampen external

performance. Strong domestic demand contributed to high-capacity utilization rates, and

unemployment reached a 16-year low in 2003. Inflation declined to about 1½ percent in the

year to December 2003, reflecting the impact of the currency appreciation. The currency has

appreciated by 66 percent against the U.S. dollar and 36 percent on a trade weighted basis

between December 2001 and February 2004. The current account deficit is approaching a

three-year high of 4½ percent of GDP, reflecting the relatively strong cyclical position of the

New Zealand economy and the substantial appreciation of the NZD (Table 2).

B. Financial Sector Context

7. New Zealand’s financial sector and its regulatory environment underwent

significant changes over the past two decades. Previously dominated by publicly-owned

banks, which operated in a tightly regulated market, the sector is now almost fully in private,

foreign ownership, and the scope of regulation has been radically reduced from that of the

mid 1980s. NBFIs and securities markets have declined in importance and are now secondary

players, as banks have expanded their range of activities.

The banking sector

8. The banking sector includes 18 registered banks and, at end-2002, held assets

exceeding $NZ 200 billion (about 160 percent of GDP). Only two smaller banks are New

Zealand-owned, including a recently formed retail bank that is owned by the

government-owned post office (NZ Post). Ten banks operate as foreign branches, five are

local subsidiaries of foreign parent banks, and one is a joint venture between a foreign bank

and a local company.

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Table 2. New Zealand: Selected Macroeconomic Indicators, 1999–2003

(End of period, unless otherwise stated)

1999 2000 2001 2002 2003

Total population (million, end-2002) 3.942

GDP per capita (2002) in USD 16,762

Real sector

Real GDP (percentage change) 4.0 3.9 2.7 4.3 3.5

Nominal GDP (in NZD billion) 105.7 112.3 120.5 126.4 133.1

CPI inflation (e.o.p.) 0.5 4.0 1.8 2.7 1.6

Household savings ratio (in percent of disposable income) 4.8 -0.8 -4.4 -3.1 -8.2

Monetary and credit data (change in annual averages)

Monetary base 19.0 8.9 9.6 9.2 6.6

Money (M1) 19.5 6.9 15.3 12.8 7.8

Broad money (M3) 3.5 3.4 13.5 11.9 6.1

Domestic credit 8.3 8.5 7.6 12.1 5.3

Yield on government bills 5.2 6.7 5.9 5.8 5.4

Yield on government bonds 6.4 6.9 6.4 6.4 5.8

Reference bank lending rate 1/ 8.5 10.2 9.9 9.8 9.8

Yield spread, 90-day to 10-year bonds (b. p., end of period) 166 -66 191 13 41

Stock market index (percent change, end of period) 6.8 -13.8 8.0 -5.1 25.6

Public finances (in percent of GDP)

Central government financial balance (operating balance) 1.5 1.3 1.6 1.7 3.0

Central government net of revaluations and accounting

changes

0.2 0.8 1.8 2.2 4.3

External sector (levels, unless otherwise indicated)

USD exchange rate (end of period) 0.52 0.44 0.42 0.53 0.66

Trade balance (NZD billion) -0.8 1.4 3.1 0.7 -1.5

Current account (NZD billion) -6.7 -5.5 -3.1 -4.7 -5.9

Foreign direct investment (Net, NZD billion) 0.6 2.0 3.0 0.4 ...

Portfolio investment (Net, NZD billion) -3.0 -0.7 0.4 1.8 ...

Gross official reserves, e.o.p. (USD billion) 4.5 3.9 3.6 4.8 5.1

Reserve cover (expressed in months of imports) 2/ 2.5 2.4 2.6 2.3 3.7

Reserve cover (short-term external debt) 17.7 15.9 15.0 13.0 16.3

Total external debt (NZD billion) 102.9 99.9 110.2 108.8 103.9

of which: Public sector debt (NZD billion) 3/ 17.4 17.3 16.7 18.5 18.7

of which: Banking sector debt (NZD billion) - loans only ... 60.3 70.6 71.4 76.0

Central bank short-term foreign-currency liabilities

(NZD billion) 4/

0.7 1.4 0.7 1.0 0.7

Sources: Statistics New Zealand, RBNZ, New Zealand Stock Exchange, and New Zealand Treasury.

1/ This is a surveyed retail interest rate and represents a “base” lending rate offered to new business borrowers,

weighted by each surveyed institution’s total NZ dollar claims.

2/ Imports of goods and services (excluding factor income).

3/ Annual figures for 1998 and 1999, December quarter for 2000–02, June quarter for 2003.

4/ Remaining maturities of one year or less.

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Table 3. New Zealand: Financial Soundness Indicators, 1999–2003

(In percent, unless otherwise indicated)

1999 2000 2001 2002 Jun-03 Sep-03

Banking sector 1/

Total system assets (NZD billion) 158.4 180.1 189.6 204.5 212.5 ...

Total assets of locally incorporated banks (NZD billion) 107.9 116.0 126.7 135.2 142.5 ...

Share of system assets in foreign branches 31.9 35.6 33.2 33.9 32.9 ...

Capital adequacy 2/

Tier 1 regulatory capital to risk-weighted assets (weighted average) 7.1 7.7 7.6 8.5 8.6 ...

Minimum observed tier 1 regulatory capital to risk-weighted assets 6.5 6.7 6.3 7.1 7.7 ...

Total regulatory capital to risk-weighted assets (weighted average) 10.3 11.1 10.7 11.3 11.4 ...

Minimum observed total regulatory capital to risk-weighted assets 9.6 9.6 9.5 10.5 10.3 ...

Aggregate system equity to aggregate system assets 3.2 2.8 2.7 2.5 2.4 ...

Aggregate equity asset ratio for locally incorporated banks 4.6 4.3 4.0 3.7 3.5 ...

Asset composition

Investments as a percentage of total system assets

Balances with central banks and other financial institutions 4.0 3.9 4.4 3.7 3.8 ...

Government bond holdings 1.8 1.7 1.4 1.5 1.3 ...

Other trading securities 7.6 6.5 5.9 5.8 5.0 ...

Total liquid assets 13.4 12.1 11.7 11.0 10.1 ...

Loans, advances and lease finance 77.0 72.9 75.8 75.9 75.9 ...

Sectoral distribution of loans to total loans

Households 47 46 45 45 47 48

Financial sector 1/ 7 6 5 6 5 4

Insurance sector 1/ 1 0 0 0 0 0

Construction sector 1/ 1 1 1 1 1 1

Communications sector 1/ 1 0 0 0 0 0

Non-residents 1/ 7 11 13 14 13 12

Mortgage loans (residential and commercial) 1/ 50 58 56 57 59 59

Aggregate risk-weighted assets to total assets 1/ 67 64 65 64 63 63

Asset quality and provisioning

Aggregate impaired assets to total assets (in basis points) 1/ 34.1 30.4 31.7 25.4 28.1 ...

Aggregate impaired and past due assets to total assets (in basis points) 47.8 44.8 88.4 53.6 55.7 ...

Aggregate total provisions to total assets (in basis points) 3/ 43.7 39 36.3 35.3 43.1 ...

Aggregate specific provisions to total assets (in basis points) 3/ 12.7 10.3 8.1 9.5 8.8 ...

Aggregate total provisions to total impaired and past due assets 3/ 91.4 87.1 41.1 65.9 77.4 ...

Aggregate specific provisions to impaired assets 3/ 37.2 33.9 25.4 37.4 31.3 ...

Earnings and profitability

Profit before tax and provisions to average assets 1.5 1.5 1.7 1.9 2.0 ...

Profit after tax and extraordinary items to average assets 1.1 1.1 1.1 1.3 1.3 ...

Profit after tax and extraordinary items to average equity 22.5 24.0 24.6 26.1 24.2 ...

Interest margin 2.4 2.3 2.3 2.6 2.6 ...

Noninterest income to total revenues 36.1 37.8 36.7 32.4 32.4 ...

Total operating expenses to total revenues 56.9 54.8 48.4 45.5 44.0 ...

Funding and liquidity

Liquid assets to total assets 13.4 12.1 11.7 11.0 10.1 ...

Liquid assets to deposits and other borrowings 28.6 26.9 23.7 22.3 19.8 ...

Loans, advances, and lease finance to deposits and other borrowings 105.2 105.9 102.2 101.6 100.2 ...

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Table 3. New Zealand: Financial Soundness Indicators, 1999–2003 (continued)

(In percent, unless otherwise indicated)

1999 2000 2001 2002 Jun-03 Sep-03

Funding and liquidity (continued)

Loans, advances, and lease finance to NZD retail funding 192.8 195.5 188.1 186.0 185.0 ...

Liabilities to related entities to total liabilities 16.2 19.3 15.5 12.7 11.1 ...

Share of total liabilities owed to nonresidents 29.2 31.0 33.9 30.5 29.0 29.3

FX denominated liabilities to total liabilities 21.9 22.5 22.6 18.2 19.4 19.3

Share of FX denominated liabilities owed to related entities 53.5 39.2 47.5 37.5 33.0 33.0

Banking sector sensitivity to market risk

Avg. peak end-of day interest rate exposure as a share of equity 4/ 1.9 1.6 1.5 1.4 1.4 ...

Avg. end-of period interest rate exposure as a share of equity 4/ 1.5 1.3 1.2 1.3 1.1 ...

Avg. peak end-of day FX exposure as a share of equity (b.p.) 4/ 5/ 6.8 7.8 6.1 6.2 10.3 ...

Avg. peak end-of day equity exposure as a share of equity (b.p.) 4/ 0.6 0.6 1.8 1.2 0.6 ...

Insurance sector indicators -Life Insurance

Growth rate of gross premiums written (% change from last year) 3.9 -8.6 -5.3 2.9 ... ...

Life Surplus to Total Assets 13.0 12.0 13.9 16.6 ... ...

Investment income / Investment assets 9.5 6.4 2.8 -3.1 ... ...

Insurance sector indicators - Non Life Insurance

Growth rate of gross premiums written (% change from last year) 3.8 4.9 -2.2 4.3 ... ...

Combined ratio 99.1 100.0 101.3 98.5 ... ...

Investment income to investment assets 4.9 6.3 5.5 4.0 ... ...

Underwriting profit to net investment income 16.4 -0.2 -18.7 42.6 ... ...

Solvency Margin 63.5 61.8 67.2 59.7 ... ...

Household sector indicators

Rate of growth of assets 5.9 1.2 4.6 9.0 ... ...

Rate of growth of liabilities 10.5 6.8 8.0 10.0 ... ...

Rate of growth of housing value 5.2 1.0 5.2 14.8 ... 23.8

Rate of growth of personal bankruptcies -6.9 -8.6 8.6 -10.4 ... 3.8

Net financial assets to disposable income 72.6 67.2 60.8 47.6 ... ...

Debt servicing cost to disposable income 8.0 9.1 8.4 9.0 ... 9.2

Corporate sector indicators

Corporate debt to equity ratio 87.9 93.2 96.4 95.0 ... ...

Growth rate of company liquidations -29.7 -22.6 -26.9 -47.2 ... ...

EBITDA to interest expenses 248.7 251.8 257.9 325.1 ... ...

ROA 4.0 3.7 3.6 4.6 ... ...

ROE 9.5 9.5 9.6 12.4 ... ...

Current ratio 127.9 121.0 124.3 130.5 ... ...

Source: Reserve Bank of New Zealand, Ministry of Economic Development, Statistics New Zealand.

1/ Excludes interbank exposures, NZD claims for residents, all non-resident claims.

2/ Includes only local incorporated banks.

3/ Excludes interbank exposures. June 2003 flow data represent 12 month running totals.

4/ Simple average of order in council market risk measures. June 2003 flow data represent 12 month running totals.

5/ 1998 average excludes one small bank with an extreme reported value.

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Table 4. New Zealand: Financial System Structure, 2000–02

(End of period, unless otherwise stated)

Number Assets

(NZD billion)

Percent of

Total Assets

2000 2001 2002 2000 2001 2002 2000 2001 2002

Banks

18 17 17

180.1 189.6 204.5 70.7 71.2 73.6

Domestic 1 2 2

1.4 1.7 2.2 0.5 0.6 0.8

Foreign-owned branches 11 10 10

64.2 62.3 69.3 25.2 23.4 24.9

Foreign-owned, incorporated locally 6 5 5

114.6 125.0 133.0 45.0 46.9 47.8

Nonbanks

311 303 290 74.5 76.8 73.5

29.3 28.8 26.4

Managed funds 1/ 56 56 56

47.5 47.9 44.4 18.7 18.0 16.0

Life insurance companies 39 40 36

12.4 12.0 10.7 4.9 4.5 3.8

Non-life insurance companies 85 83 75

3.7 4.0 3.5 1.5 1.5 1.3

Finance companies 46 48 50

6.0 7.7 9.2 2.4 2.9 3.3

Building societies 2/ 10 10 11

2.4 2.6 2.9 0.9 1.0 1.0

Credit unions 74 65 61

0.4 0.4 0.4 0.2 0.2 0.1

Bonus Bonds Trust 1 1 1

2.1 2.2 2.4 0.8 0.8 0.9

Total financial system

329 320 307

254.6 266.4 278.0 100.0 100.0 100.0

Sources:

Banks - Individual Bank Disclosure statements.

Superannuation - Government Actuary annual report, with 2002 estimated from RBNZ partial survey data.

Managed funds - RBNZ quarterly and annual surveys.

Life insurance companies & Non-life insurance companies - MED, Insurance and Superannuation Unit.

Finance companies - Reserve Bank, Annual Statistical Return and Reserve Bank Bulletin June 2003.

Building societies - Reserve Bank, Annual Statistical Return.

Credit unions - Report of the registrar of credit unions.

1/ Managed funds (superannuation, unit trust, group investment funds, excluding insurance companies): data are funds

under management. Include ten large charities as fund managers.

2/ Building societies have added to them the Public Service Investment Society (PSIS), a similar kind of savings

intermediary.

9. New Zealand’s banking sector is profitable and well capitalized. Over the last five

years aggregate industry return on assets has exceeded 1½ percent, and after-tax returns on

equity have consistently exceeded 20 percent. Capitalization, whether measured by

equity-asset ratios or by regulatory capital measures, is above international minimum

prudential benchmarks. The aggregate equity-asset ratio of locally incorporated banks is

4.6 percent. Tier 1 regulatory capital adequacy ratios (CARs) are all in excess of 8.5 percent

and total CARs are approaching 11.5 percent (Table 3). Among registered banks, the least

well-capitalized institution has a Tier 1 CAR of 7.7 percent and a total CAR of 10.3 percent.

Impaired assets are low, comprising only slightly more than 0.5 percent of bank assets.

- 12 -

General and specific provisions cover about three-quarters of total impaired and overdue

assets.

10. The banking sector is dominated by five registered banks. They hold nearly

90 percent of the sector’s assets and deposits (Table 4), and earn more than 80 percent of

industry profits. One of the five banks operates as a branch of an Australian parent, despite a

recently amended rule that is intended to require local incorporation for systemically

important banks. The other four banks are subsidiaries of Australian parent banks.

11. Banks are retail oriented, with mortgage lending amounting to nearly 60 percent

of the overall loan portfolio, and have only modest exposures to other sectors.

Agricultural loans are the second most important group, accounting for slightly more than

11 percent of lending. Lending for purposes other than property acquisition may be

understated in official statistics, as consumer and small business loans reportedly are often

secured by residential property. Given the high share of mortgages, recent increases in house

prices have given rise to concerns about a possible reversal of property prices. Banks have

argued that risk mitigating factors include the low average loan-to-value ratios of about

60 percent, conservative conditions on new lending (with most lending above a loan-to-value

ratio of 80 percent covered by mortgage insurance). Also, there is a substantial increase in

the demand for housing due to net immigration and cultural preference for home ownership.

Stress tests conducted as part of the Financial Sector Assessment Program (FSAP)

(Section III) examine this issue further.

12. The banking system is funded to a large extent by domestic deposits. A

significant share of the country’s capital inflows are, however, borrowings undertaken by the

banking sector. About 30 percent of bank liabilities (nearly 50 percent of GDP) are owed to

nonresidents (Table 3). About half of the foreign liabilities of banks are to affiliates. About

one-third of banks’ foreign borrowing is denominated in NZDs, with the rest split between

Australian dollars, U.S. dollars, and other currencies, generally swapped back into NZDs.

Only a minor share of the foreign borrowing is on-lent in foreign currency.

Nonbank financial institutions (NBFIs)

13. The nonbank financial sector accounts for only a quarter of financial system

assets (Table 4). Among the different institutions, managed funds—superannuation funds,

unit trusts, and group funds—account for the largest share of system assets at 16 percent.

Insurance companies account for another five percent of assets, followed by finance

companies with three percent of assets. Building societies and credit unions are quite small,

with less than one percent of system assets.

14. The managed funds industry is the most important vehicle for investing

household funds outside of the banking system, accounting for $NZ 44 billion in assets

at end-2002. Almost two-thirds of managed funds are invested in unit trusts or group

investment funds. Two of the largest funds-management companies are owned by major

banks and two by large multinational insurance companies. Private superannuation funds are

- 13 -

also a significant component of the managed funds sector, accounting for $NZ 17 billion in

assets at end-2002. However, the removal of tax incentives has reduced the importance of

these funds as a vehicle for household savings. A new government-run New Zealand

Superannuation Fund was established in 2001 to partially pre-fund the public pension

system. At end-January 2004, it had about $NZ 3.1 billion in assets, and is expected to grow

by about $NZ 2 billion a year.

15. The insurance sector in New Zealand remains small relative to other countries.

Measured in premiums per capita, New Zealand ranks only twenty-eighth in the world. Life

insurance is dominated by a bank subsidiary and three subsidiaries of major foreign

insurance companies, but the remaining four large banks also have life insurance affiliates.

The life insurance sector has gradually declined in importance over the past five years, due to

competition from other products and institutions. In contrast, the nonlife sector has enjoyed

stable growth and now amounts to almost twice the life insurance market by premium

income. Two government-run agencies (the Accident Compensation Commission and the

Earthquake Commission) provide mandatory workers compensation/accident insurance and

earthquake insurance, respectively. These agencies held approximately $NZ 5.9 billion and

$NZ 4.1 billion in assets at end-June 2003.

16. Finance companies, building societies, and credit unions undertake bank-like

activities and finance themselves largely by deposit taking. Finance companies and

building societies have grown rapidly in the past five years, but remain small compared to the

major banks. Credit unions have declined in size and membership, holding less than one

percent of total financial system assets. Finance companies operate in areas not fully covered

by the major banks, including household lending (where finance companies provide over a

third of consumer credit); higher-risk property lending; and vehicle, plant, and machinery

leasing. Building societies concentrate on deposit taking and property lending only. The

largest finance company is a subsidiary of one of the major banks; most others are privately

held. The sector is profitable, with returns on equity above 20 percent for the sector as a

whole, and returns on assets of around 2 percent. Building societies, which are member-

owned, are also profitable but lag behind banks and finance companies, with returns on

equity averaging nine percent for the last three years and return on assets averaging about

0.75 percent.

Securities markets

17. New Zealand equity markets are comparatively small with market capitalization

of about 44 percent of GDP. Reflecting a preference for property investment, ownership of

New Zealand-listed equities remains mostly in the hands of offshore investors and domestic

institutional investors, with only about one-fourth held directly by households. Securities

market intermediaries include share brokers, futures dealers, investment advisers, and

managers of collective investment schemes (CIS). The New Zealand Stock Exchange (NZX)

is the country’s only registered securities exchange and was demutualized in December 2002.

Efforts are underway to increase access by small- and medium-size enterprises (SMEs),

including the recent launch of a new market with listing standards tailored to SMEs. The

- 14 -

parent corporation of the New Zealand Futures and Options Exchange (NZFOE)—the only

futures and options exchange in the country—has announced that trading in NZFOE products

will be transferred to Australia in 2004.

C. Supervision and Regulation

18. New Zealand regulators do not carry any duty to protect individual depositors

or policyholders, or to safeguard individual institutions, unlike many other

jurisdictions. There is no official deposit protection or policyholder protection scheme. The

New Zealand supervisory and regulatory framework was introduced as a component of the

financial sector reforms initiated in the 1980s, while much of the current nonbank regulatory

framework, particularly in relation to securities markets, was established in the 1970s.

The banking sector

19. The current supervision framework is built around three main pillars: self

discipline, market discipline, and regulatory discipline. A cornerstone of the

self-discipline component is a requirement that directors attest quarterly that their bank’s

risk-management systems are adequate, and that they are being properly applied. This

procedure reinforces self discipline and reduces complacency by threatening civil and

criminal penalties in case of noncompliance and by exposing directors in the event of

misleading or adverse disclosures. Market discipline is promoted through the issuance of

quarterly disclosure statements on the bank’s financial condition, risk profiles, and risk-

management policies. Market discipline is reinforced by the absence of deposit insurance,

and a cultural ethos of “buyer beware.” The disclosure requirements and associated audit

requirements are meant to ensure that higher-quality data is provided to creditors and

investors on a more frequent basis than would otherwise be the norm. Finally, regulatory

discipline is enforced through the application of various prudential requirements by the

RBNZ, which is charged with licensing and supervising registered banks.

20. The RBNZ has a range of enforcement powers, and complements self- and

market discipline with off-site reviews and high-level discussions with banks. Activities

include regular RBNZ scrutiny of all quarterly disclosure statements, maintenance of active

working relationships with banks through annual consultation with senior management, as

well as through more informal contacts, regular meetings with other bank regulators and

credit-rating agencies, and annual meetings with the boards of the larger banks. However, the

RBNZ lacks a regular or targeted on-site supervision program, even though its Act does

provide the necessary powers to do so. Recent legislative changes have expanded the

RBNZ’s powers in certain areas, including a prior approval requirement for all significant

changes in bank ownership. The 2003 amendments to the RBNZ Act have also clarified and

expanded the Bank’s registration and enforcement powers and obligations.

21. The RBNZ achieved material compliance with most Basel Core Principles in the

assessment of observance, in spite of the special features of the regulatory framework.

Where differences exist, for example, in the monitoring of credit risks, these relate in some

- 15 -

cases to a conscious decision to leave oversight of such risks largely to the market. In other

cases, certain risks that are not supervised are not currently relevant to New Zealand.

22. A second layer of supervision is provided by the home-country supervision of all

the systemically important banks and their nonbank subsidiaries. The parent companies

of the local banks have generally imposed their own credit culture and risk-management

policies, systems, and procedures on their subsidiaries; such systems have already been

vetted by the home-country supervisor and are designed to meet its prudential requirements.

Home supervisors also conduct periodic on-site visits. The RBNZ has signed memoranda of

understanding with the Australian Prudential Regulation Authority and the U.K. Financial

Services Authority. The RBNZ maintains regular contact with foreign authorities, but does

not participate in on-site work nor does it receive supervisory reports sent to home-country

regulators.

Nonbank financial institutions and securities markets

23. Oversight of much of the nonbank sector and securities markets is indirect.

Reliance is placed upon a combination of market disclosure, rating agency assessments,

monitoring activities of self-regulatory organizations, trustees and auditors, and licensing and

registration requirements for certain categories of institutions.

24. For both the nonbank financial sector and securities markets, substantial

reliance is placed on self-regulatory organizations, trustees acting as private monitors,

and on the auditors of financial statements to ensure the provision of accurate

information. Additional oversight is provided by regulators outside of New Zealand for a

handful of the largest institutions (which account for over half the sector’s total assets),

because they are subsidiaries of large multinational banks or insurance companies. A large

number of NBFIs are not monitored by an overseas regulator or an exchange, since they are

domestically owned. While none of them is systemically important, the failure of any of the

larger nonbank institutions could nevertheless have a significant impact on market stability

through negative reputational effects on other institutions.

25. The Ministry of Economic Development (MED) is the main regulator of

nonbank institutions through its various business units, including the Registrar of

Companies and the Government Actuary. The MED has a role in ensuring compliance

with applicable laws for insurance companies, superannuation funds, building societies, and

credit unions, and to a more limited extent finance companies and managed funds. The legal

framework grants it some enforcement powers, including the ability to: (i) compel the entities

they regulate to provide additional information, as deemed necessary to facilitate oversight

and keep investors informed; (ii) appoint auditors; (iii) suspend registration; and (iv) place

companies in statutory management or liquidation. Despite these powers, ongoing oversight,

including review of periodic financial reports, is limited for some sections of the nonbank

sector.

- 16 -

26. For the securities sector, the principal regulator is the Securities Commission,

while the Takeovers Panel and Registrar of Companies have more narrowly defined

mandates. The principal elements of the securities regulatory framework are: initial and

ongoing disclosure requirements for public issuers, including collective investment schemes;

entry standards and oversight of some market intermediaries (principally exchange

members); supervision of most collective investment scheme operators by trustees and

private supervisors; regulation of takeovers; and certain restrictions on abusive conduct in

secondary markets. For securities markets, the NZX and the NZFOE establish and monitor

prudential standards and rules for the conduct of trading on the exchange, including

disclosure requirements. Most other market intermediaries, however, are subject to minimal

or no regulatory supervision. This includes, most notably, investment advisors.

27. The government, securities regulators, and NZX are taking steps to raise the

quality of securities regulation to high international standards. To date, the government

has provided sufficient funding to the Securities Commission and the Takeover Panel to

enable them to fulfill their responsibilities. Management of NZX is investing in its regulatory

functions and it cooperates with the Securities Commission and the Takeover Panel in

addressing regulatory concerns in areas of shared responsibility. Overall, the main

government regulatory agencies, MED, Securities Commission and the RBNZ, seem well

coordinated and maintain close contacts that enable them to monitor issues relating to cross-

linkages between NBFIs and banks. However, some gaps remain in the regulatory

framework. These gaps may make it more difficult for securities regulators to detect

incompetent or fraudulent conduct at an early stage and, in some instances, to take effective

enforcement action. The government and securities regulators are aware of these weaknesses,

are familiar with the relevant international best practices, and intend to carry out significant

reforms in the next few years.

28. New Zealand’s observance of the Financial Action Task Force (FATF) Principles

for Anti–Money Laundering and Combating the Financing of Terrorism (AML/CFT) is

being assessed by a team from FATF and the Asia Pacific Group on Money Laundering

(APG). Field work has been completed, and the ROSC from the assessment will be

circulated to the Board once it is completed.

III. S

HORT-TERM STABILITY ISSUES

29. In all areas of short-term stress considered, the exposures of the New Zealand

financial system appear well-contained. Systems are in place to ensure an adequate

response if stresses were to occur.

A. Stress Testing the Financial System

30. In preparation for the FSAP, the RBNZ coordinated a stress-testing exercise

among the five systemically important banks. Stress tests were undertaken by banks and

results were aggregated by the RBNZ. The mission did not have access to individual bank

data.

- 17 -

31. The stress tests focused on risks judged relevant to the New Zealand market

(Table 5). Stress testing of the Australian parent groups of New Zealand banks was beyond

the scope of the New Zealand FSAP. Available data suggest that Australian banking groups

are profitable and well capitalized, with the New Zealand operations accounting (on average)

for less than twenty percent of group assets or profits. The mission reviewed the publicly

available reports on APRA’s stress tests of these groups, which focused on Australian

property price risks and found these risks to be manageable. Risks perceived most important

to New Zealand bank operations at this stage include significant changes in exchange rates,

New Zealand interest rates, property prices, and the price of agricultural output. The stress

test also included two dynamic macroeconomic scenarios, one based on the outbreak of foot-

and-mouth disease, a scenario that would lead to a significant shock to agricultural output

and far-reaching repercussions on the economy at large. A second scenario simulated a sharp

increase in the cost of foreign funding for New Zealand banks.

32. The results show a high degree of resilience of the banking system. Market-risk

shocks applied to bank trading books (which were large shocks compared to historical

experience) produced only small losses, given the small size of the bank’s trading book

(Table 6). A maximum loss for one bank of less than 15 percent of pre-tax profits emerges if

nominal New Zealand interest rates were to increase by 300 basis points, and bank positions

were all fixed at their most disadvantageous internal risk management limit. Results of the

credit-risk scenario, involving a 20 percent decline in property prices and some decline in

household income, would differ depending on, among other factors, portfolio concentration

on commercial property. The worst individual bank loss estimate would be below half of the

bank’s March 2003 annual pre-tax profits. These results are, in part, due to the characteristics

of bank mortgage portfolios in New Zealand, including a 60 percent average loan-to-value

ratio, and several contract features that allow homeowners to remain current on their loans

while facing temporary unemployment and reductions in income.

33. Results of the foot-and-mouth scenario suggest it would not pose a risk to the

solvency of the major banks. The dynamic scenarios are based on macroeconomic

assumptions provided by the RBNZ (Table 8). Results of these dynamic stress tests are

summarized in Figures 1 and 2. For the foot-and-mouth scenario, such a shock would impose

a modest but long-lasting drag on the profitability of systemically important banks. These

banks’ direct exposures to the agricultural sector are contained, and the exchange rate

depreciation associated with the scenario bolsters the profitability of other export industries.

In mission discussions, banks offered the opinion that the stress scenario assumptions were

perhaps too optimistic, and that a serious outbreak of foot-and-mouth disease might have

more wide-ranging effects than anticipated in the RBNZ simulations.

- 18 -

Table 5. Sensitivity Stress-Test Scenarios

Market-Risk Scenarios

Scenario Exchange Rates

1 30 percent depreciation of the New Zealand dollar relative to all other currencies

2 30 percent appreciation of the New Zealand dollar relative to all other currencies

Interest Rates

3 300 basis point increase in interest rates across the NZ yield curve

300 basis point increase in the long end (5+ years) of the NZ yield curve, short rates

unchanged

Credit-Risk Scenarios

Scenario Commodity Prices

1 A decline in the dairy payout to $2.50/kg for two consecutive years

Property prices and economic weakness

20 percent decline in residential property prices, with unemployment rising from 5

to 9 percent, and households’ real disposable income falling by 4 percent

3 20 percent fall in commercial property prices, 20 percent fall in corporate earnings

Source: RBNZ.

Table 6. Market Risk Results

Shock

Average Loss as a

Percent of 2003

Profits 2/

Largest Individual Bank

Maximum Risk Loss as a

Percent of 2003 Profits

Assuming Typical Bank Exposure

1 1.98 2.75

2 -1.00 0.39

3 2.75 3.82

4 0.43 0.91

Assuming Worst Case Exposures

1 3.80 8.60

2 -0.70 2.80

3 6.20 14.40

4 3.60 7.10

Source: RBNZ.

1/ Negative numbers represent gains.

2/ Actual reported annual pre-tax profit for the 12-month period ending in

March 2003.

- 19 -

Table 7. Credit Risk Results

Year

Average Cumulative

Loss as a Percent of

2003 Profits

Largest Individual Bank

Loss as a Percent of

2003 Profits

Credit Shock 1

1 3.09 8.33

2 4.35 11.38

Credit Shock 2

1 8.31 15.84

2 18.78 32.56

3 28.39 44.11

Credit Shock 3

1 1.90 3.46

2 6.63 10.79

3 9.76 19.50

Source: RBNZ.

1/ Actual reported annual pre-tax profit for the 12-month period ending in

March 2003.

Table 8. Model Assumptions

Foot-and-Mouth Disease Scenario Assumptions

80 percent decline in meat exports

20 percent depreciation of the New Zealand dollar against all other currencies

50 basis point increase in the risk premium for New Zealand dollar denominated

assets

A decline in the long-term capital/output ratio and net foreign assets.

Increase in Offshore Funding Costs

A depreciation of the New Zealand dollar by 40 percent

An increase of short- and long-term interest rates to 18–20 percent

A permanent increase in the risk premium on New Zealand dollar-denominated

assets

Source: RBNZ.

34. The results of the funding-costs-stress scenario show greater potential for loss.

Bank profitability falls in the early quarters of this scenario as market risk and banking book

losses are generated from a rise in interest rates and the sharp depreciation of the NZD.

Eventually, higher interest rates generate greater interest revenues as credits mature and are

- 20 -

repriced, but the rate rise and the weak economy cause a rise in residential mortgage defaults,

particularly on mortgages associated with investment properties. Lending to commercial

property developers is also expected to generate losses, yet the losses to the banking sector

will be attenuated by the losses that will be absorbed by mezzanine creditors, primarily

finance companies and contributory mortgage companies. While banks suffer depressed

profits, the results do not suggest that any bank’s capital position would be endangered by

this scenario.

Figure 1. Foot and Mouth Disease Scenario

Figure 2. Funding Shock Stress Scenario

B. Nonbank Financial Institutions

35. The NBFIs are small in comparison to the banking system, but are able to offer a

wide range of financial products similar to those offered by banks. NBFIs are subject to

prospectus and investment statement requirements under the Securities Act. However, NBFIs

are not subject to quarterly disclosure and directors’ attestations as required of banks. As a

result, there is little timely quantitative information that is readily available to depositors and

market participants. Most NBFIs are only required to report their financial results on an

annual basis, and often with a substantial reporting lag, although additional disclosures are

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1 2 3 4 5 6 7 8 9 101112131415

Stress Quarter

Proportion of baseline profits_

sample average

lower envelope

Source: RBNZ.

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

123456789101112131415

Stress Quarter

Proportion of baseline profits_

sample average

lower envelope

Source: RBNZ.

- 21 -

required if there have been material adverse developments since the date of the most recent

prospectus. Furthermore, the government entity largely responsible for collecting this

information, the MED, has only limited capacity to compile and aggregate the relevant data.

36. The main NBFIs are affiliates of the major banks or multinational financial

groups and benefit, to some extent, from the regulation imposed on their parents.

However, the lack of timely and comprehensive disclosure of individual and aggregate data

for the sector potentially reduces the effectiveness of market discipline. It may also hamper

effective early intervention, should significant problems in the sector develop which, given

ownership links and similar business practices, have the potential for direct or indirect

spillover effects on banks. Efforts to coordinate and strengthen data collection and disclosure

would help regulators, market participants, and depositors to have a more accurate and timely

picture of developments in the sector.

C. Foreign Currency Exposure and Functioning of Exchange Markets

37. The stability of the financial system could be sensitive to a number of foreign-

exchange-related issues, due to high dependence on international trade and capital

flows. These include the management of exchange rate risk, access to overseas funding, and

the liquidity of the foreign exchange market. Appropriate risk management and well

functioning markets indicate, however, that short-term risks related to foreign exchange at

this time seem contained.

Foreign currency exposure

38. Exchange rate risk in New Zealand is well understood and managed actively by

banks and other market participants. Markets have coped successfully with considerable

volatility in the exchange rate. From January 1997 to November 2000, the New Zealand

dollar depreciated by about 45 percent against the U.S. dollar, and it subsequently

appreciated by 73 percent by February 2004. As a result, banks require the adoption of

hedging policies when considering applications for loans by corporations. A very high

percentage of foreign-currency-denominated overseas debt is hedged: over 96 percent in the

banking sector and 78 percent in other sectors, thus greatly reducing balance sheet risks.

Approximately 70 percent of the hedging is done using financial contracts with the remainder

naturally hedged against foreign exchange assets or receipts. Operational foreign exchange

risk is also very conservatively managed with large exporters consistently hedging

receivables and forecasting receipts over their planning horizon. The public sector has no net

foreign-exchange-denominated debt.

39. There is little evidence of major residual NZD exchange rate risk remaining for

the country. Exchange rate risk is frequently intermediated separately from the credit risk

(via the derivative markets) and often passes through a number of intermediaries, with

market participants themselves unaware of the end-recipient. New Zealand institutions and

statistical services do not attempt to identify market participants in any systematic fashion,

and thus it is difficult to determine the ultimate bearer of NZD risk. However, the following

- 22 -

factors seem to mitigate any possible risk for New Zealand: (i) counterparties to hedges seem

to be varied, but all of them are nondomestic entities, including foreign households and retail

investors, overseas insurance companies and fund managers, and international currency

overlay investors and hedge funds; (ii) market participants appear to be widely dispersed

geographically and are relatively numerous, so the risk is not overly concentrated in one

country or type of investor; and (iii) the demand for New Zealand dollar risk appears to be

fairly steady over time, as evidenced by the ability to hedge New Zealand currency risk

consistently over time and in a large variety of market conditions, and the fact that almost

half of New Zealand’s international financial liabilities are denominated in domestic

currency.

Foreign exchange market

40. The foreign exchange market in New Zealand functions efficiently and provides

a reasonable degree of liquidity, commensurate with the size of the New Zealand

economy. Seven banks are currently market makers in the NZD, and most trading now takes

place outside of New Zealand—primarily in Australia, but also in London and New York. In

April 2001, average daily trading volume in Australia and New Zealand was approximately

$NZ 2.8 billion in the spot market and $NZ 13 billion in the swap market. There are

indications that trading volumes have declined, possibly substantially, since then. Trading

spreads are similar to those of other comparable currencies. Settlement risk is present but will

be greatly reduced when the New Zealand dollar becomes eligible for inclusion in the

Continuous Linked Settlement (CLS) Bank, currently expected by end-2004.

41. The RBNZ maintains limited liquid reserves (approximately $NZ 4.3 billion)

and the technical capability to intervene in foreign exchange markets, although it has

not intervened since 1985. This framework provides a limited safety net, as it would allow

the bank to intervene in order to restore liquidity to a severely disrupted FX market, reducing

possible systemic risks for the New Zealand economy. The RBNZ has recently

recommended to the Minister of Finance that the RBNZ, as one of its policy implementation

tools, should have the capacity to intervene to influence the level of the exchange rate when

the rate was “exceptionally and unjustifiably” high or low.

D. Money and Bond Markets

42. The money market in New Zealand consists of a range of short-term debt

instruments, including treasury bills, bank bills, and commercial paper, together with a

variety of derivative financial instruments, such as bank bill futures, interest rate swaps

and options, and forward-rate agreements. Secondary markets for most instruments exist,

with the market for bank bills and their futures being the most liquid. The secondary market

for treasury bills and commercial paper is much less liquid because investors tend to hold

these instruments until maturity. Trading activity is dominated by five or six of the major

banks and three brokers.

- 23 -

43. New Zealand bond markets are dominated by government bonds, with around

$NZ 21.8 billion outstanding. Government bonds are the most liquid instrument, with daily

turnover in the secondary market around $NZ 3 billion, mostly in repo transactions. The

bonds are issued through the New Zealand Debt Management Office, a branch of the New

Zealand Treasury, with the RBNZ acting as agent. There are about 10 active bidders in the

regular tenders, held approximately 12 times a year. In the secondary market, there are seven

price makers and three active brokers. The larger corporates, banks, and state-owned

enterprises with investment-grade credit ratings issue corporate bonds, mostly by tender or

private placement. At present, there are around $NZ 7.2 billion outstanding for

approximately 30 issuers, mostly with maturities of three to seven years. Most issues are

illiquid. There is also a relatively large market in Eurokiwi bonds (presently around

$NZ 11.9 billion outstanding), which are denominated in NZD and offered by offshore

entities to investors outside of New Zealand.

E. Systemic Liquidity Provision

44. The RBNZ is actively involved in liquidity management through its daily open

market operations (OMO), including foreign exchange swaps. It also has a range of

standing facilities, in the context of the overnight interest rate target (the Official Cash Rate

or OCR). The interbank market for overnight funds appears to function well, with most banks

able to meet their liquidity needs either from other market participants through secured and

unsecured lending or from the daily injection of funds through OMO. Market frictions

occasionally occur when there are imbalances in holdings of government bonds (such as one

bank accumulating a large position in cash or government securities). In these circumstances,

banks prefer to pay a penalty rate (of 25 or 30 basis points above the OCR) to the RBNZ for

the use of its standing facilities. This is in preference to paying banks holding surplus

liquidity a rate at or above the OCR when secured with government securities, and depart

from the market convention of settling transactions at the OCR rate. The repeated nature of

transactions in a small market with a limited number of players seems to promote the

maintenance of this convention.

45. The RBNZ appears to have sufficient information to be able to detect and

respond to any short-term liquidity difficulties should they arise. The RBNZ has frequent

contact throughout the day with market participants and collects information on a daily basis

on interbank lending positions. The RBNZ also monitors transactions in the payment system

for signs of settlement difficulties.

However, the fact that the market does not always clear

because of stickiness in the price raises issues about how the market might react to

disruptions in interbank markets. The standing facilities in place provide a convenient

mechanism for banks to acquire liquidity from the central bank in the event of market

The mission did not undertake an assessment of the payment system. The RBNZ did

provide a detailed self-assessment of the Core Principles for Systemically Important Payment

Systems, which did not indicate any major deficiencies.

- 24 -

frictions. The RBNZ has adequate powers under the Reserve Bank Act to provide lender-of-

last-resort (LoLR) facilities, but since the revision of the Reserve Bank of New Zealand Act

in 1989, the RBNZ has not provided emergency liquidity support to any institution. The

RBNZ is presently reviewing its internal policies relating to LoLR facilities in connection

with efforts to formalize crisis management approaches.

IV. MEDIUM-TERM AND STRUCTURAL ISSUES

46. The ongoing changes in the financial sector landscape and ownership patterns

imply a need to reinvigorate the regulatory and operating framework to keep it up-to-

date. Adaptations may be called for in several areas. First, the regulatory approach may leave

the RBNZ and other regulators at times without the optimal level of information to make

informed judgments about systemic issues. Second, there are open questions regarding how a

financial crisis might be addressed. Finally, increased financial interdependence with

Australia and other financial centers may need to be more explicitly acknowledged in the

formulation of the regulatory framework.

A. Banking Supervision

47. New Zealand led the way in disclosure when it was first introduced, and it

achieved a high degree of financial sector stability within this framework. Since that

time, international best practices for disclosure have evolved and, in some instances, have

surpassed practices in New Zealand. Disclosure remains a valuable discipline on banks, and

New Zealand’s banking system is more transparent than many others. However, the

information disclosed in the quarterly statements could be enhanced to provide more

effective market discipline. Disclosure statements do not appear to be widely used at the

retail level, and are not sufficiently comprehensive or timely to be used by wholesale

counterparties for assessing creditworthiness, nor for some supervisory judgments. It would,

therefore, be appropriate to review the contents of the statements and supplement them with

focused, prudential information directly for the supervisor. The RBNZ might benefit from

having its own set of early-warning indicators, which should include, inter alia, information

on individual bank liquidity and large exposures.

48. There are almost no independent supervisory checks on banks’ systems and

controls, aside from external auditors’ checks. This reflects the current regulatory

philosophy, but such checks need not be overly intrusive, if properly focused. They can also

add value, both in identifying incipient weaknesses in individual banks and by enabling the

RBNZ to draw best-practice lessons for the banking system as a whole. The RBNZ might

consider commissioning third-party reports and establishing a small, specialist team in-house

to make focused, on-site visits on particular aspects of credit and operational risk.

49. Directors play a critical part in the New Zealand approach to banking

supervision. It is therefore important that the fit-and-proper criteria be kept under review and

the vetting process be sufficiently thorough. The role is demanding, and independent

- 25 -

directors might benefit from more regular communication with the RBNZ, perhaps at an

annual meeting to review developments and any issues they might have.

B. Crisis Management

50. New Zealand’s regulatory philosophy and the absence of depositor protection, in

conjunction with the almost fully foreign-owned banking system, would pose particular

challenges if a banking crisis were to emerge. Key concerns for crisis resolution include:

(i) the ability of the RBNZ to act as an LoLR; (ii) foreign bank branches being systemically

important; and (iii) subsidiaries of foreign banks, while having legal standing, being unable

to be economically viable on their own.

Lender-of-last-resort powers

51. Under the Reserve Bank Act, the RBNZ is required to act as an LoLR when

needed to ensure the soundness of the financial system. In formulating its LoLR policies,

the RBNZ has specified that it would only provide credit to an institution whose solvency is

not in material doubt, after the institution had fully exhausted market sources of liquidity, and

where it is necessary to maintain the stability of the financial system.

52. The RBNZ’s monitoring may not provide sufficient information at the onset of a

sudden crisis situation. The information that would be used by the RBNZ to independently

determine an institution’s eligibility for LoLR operations have not been formally articulated.

The RBNZ may not have access to sufficiently timely and detailed supervisory data that

could be utilized to make a speedy judgment about an institution’s solvency. The RBNZ can

request further information from a bank under Section 93, but a response may take

significant time. The present LoLR system relies heavily on directors’ or parent-banks’

attestations as to the solvency of a New Zealand bank operation. The RBNZ may wish to

consider again whether additional or more timely information might help it reach a better

judgment on solvency in a crisis situation.

Problem bank resolution policies

53. The RBNZ approach to banking supervision and the dominance of foreign

institutions in the financial system may complicate bank resolution, especially in the

case of systemically important institutions. The “hands-off” supervisory approach and

reliance on disclosure requirements may delay detection of emerging problems, thus

lengthening supervisory response time in a crisis. Furthermore, the range of remedial actions

that the RBNZ can take in response to a bank in difficulties is complicated for foreign

branches by legal uncertainties surrounding which assets and liabilities would be subject to

statutory management control. For a foreign-owned subsidiary, the dependence on the parent

bank can present difficulties in determining the true condition of the bank, and could also

give rise to cross-jurisdictional issues and other delays. These issues are particularly acute for

New Zealand, because all of the systemically important banks are foreign-owned.

- 26 -

54. To enhance financial stability, the RBNZ has been reviewing a range of

alternative policy options, including a specific open-bank resolution policy based on

recapitalization by creditors. The RBNZ has been conducting feasibility studies and is

attempting to clarify IT-related and other issues, with a view to making it operational. The

options to effect a bank resolution could include other alternatives such as a government bail-

out, a recapitalization with loss sharing between the government and depositors, orderly

liquidation, or a “lifeboat” rescue by the banking industry. The RBNZ’s bank resolution

policies are not yet fully defined and warrant further assessment, in the context of the overall

range of options available to address bank failures and resolution.

C. Cooperation with Australia

55. The recent increase in Australian ownership of banking assets has raised the

awareness of the high degree of interdependence between New Zealand and Australia’s

banking systems. Specific concerns about this interdependence include: (i) loss of control

over systems and functions; (ii) effects of Australian depositor protection on New Zealand

depositors; and (iii) regulatory harmonization between both countries. All issues are under

review by the RBNZ and are actively discussed with Australian counterparts; however, the

dialogue may need to be intensified to achieve satisfactory progress in a reasonable time

frame. In parallel with these discussions, the RBNZ is working on stand-alone policies

regarding local incorporation, director attestations, and outsourcing, in recognition of the

need for more immediate responses to certain developments.

56. Closer integration of foreign-owned banks and other financial institutions has

led to increasing outsourcing of IT and management functions to parent companies.

Such outsourcing has been driven by efficiency considerations and occurred both in

subsidiaries and in branches of foreign banks. The RBNZ estimates that at least half of the

banks operating in New Zealand are no longer operating as separable entities, given that

account and back-up information may not be readily available on site in New Zealand or in

an accessible back-up site. While this will not be a concern in normal times, it will be a

serious impediment to the RBNZ’s actions in case of a systemic crisis.

57. To avoid further “hollowing out” of core functionality, the RBNZ is working

with banks on assessing where core functions are being located. It plans to use the

conditions of registration to ensure that necessary management skills and back-up sites are

available in New Zealand. Preliminary discussions of the issue have taken place with the

Australian regulators, but further contact and a coordinated response to “third-party

outsourcing” might be necessary. The RBNZ might also want to consider increasing its

systematic knowledge about the core functionality of the New Zealand banks through a

targeted audit of banks.

Parent companies themselves have also outsourced some services, possibly beyond the full

reach of the home-country regulator.

- 27 -

58. A second concern for the New Zealand authorities relates to the possible effects

of the Australian depositor-preference scheme and its possible negative effects on New

Zealand depositors in case of a crisis. The Australian depositor-preference scheme

prescribes priority of Australian depositors over assets in Australia in the case of a bank

resolution. The issue is of particular concern in the case of one systemically important bank

operating as a branch of an Australian bank, as the parent bank may be able to shift assets

easily to Australia. However, there are also concerns that interbank-lending operations might

make it possible for banks operating as subsidiaries to concentrate assets in the home country

to the detriment of New Zealand depositors. The connected lending limits imposed by the

RBNZ may reduce the risks associated with asset shifting, and the RBNZ is also discussing

the issue with the Australian authorities, but the issue remains.

59. Banks in New Zealand are effectively subject to home- and host-country

regulations. Given the more “hands-on” approach pursued by the Australian regulators, the

additional compliance requirement for New Zealand banks arises mainly in the preparation of

quarterly rather than six-monthly disclosure statements. There are also some differences in

capital adequacy requirements, and the RBNZ also imposes additional requirements

concerning connected lending limits. Going forward, though, as the regulatory regime

changes, issues could arise; for example, with regard to Basel II where New Zealand plans to

implement the standardized approach and Australia plans to adopt the internal ratings-based

approach. The extent and possible implications of such reforms should be discussed among

regulators before a final decision on new regulation is made.

- 28 - ANNEX

OBSERVANCE OF STANDARDS AND CODES—SUMMARY ASSESSMENTS

Summary of Assessments of International Standards and Codes

Basel Core Principles for Banking Supervision (BCP)

New Zealand has a unique regulatory system, but has nevertheless achieved a significant degree of compliance with the

BCP.

• Supervision is conducted mainly through disclosure, director attestation, and more frequent external audit

requirements, but there are also key prudential requirements on capital, on connected lending, and on the

composition of bank’s boards of directors.

• There is a general consensus among industry participants that director attestations have instilled a strong discipline

with respect to oversight of a bank’s risk-monitoring and management systems.

• With respect to principles addressing credit (CP 7) and risk management (CPs 12 and 13), a primary reliance on

disclosure and director attestation allows information gaps that may compromise the RBNZ’s ability to detect or

anticipate incipient problems.

• On other principles, including those addressing acquisitions or investments by banks (CP 5), large exposure limits

(CP 9) and onsite supervision (CP 16), there is limited RBNZ intervention; creating actual or potential gaps that

could undermine the effectiveness of its supervision program.

• The RBNZ’s role in anti-money laundering (AML) needs to be clarified; its hands-off approach in the AML area

creates significant vulnerabilities in an environment where the relevant government agencies are underresourced and

their respective roles still ill-defined. Responsibilities for AML duties should be clearly assigned by mutual

agreement between the relevant agencies.

IOSCO Objectives and Principles of Securities Regulation

Recent changes in securities regulation and the restructuring of NZX have strengthened the regulatory framework.

Further reforms are planned.

• Securities regulators and NZX are making good use of their powers. In particular, the broad inquiry and

information-sharing powers of the Securities Commission, combined with its new enforcement powers, have

enabled it to work with other authorities to deal with many of the investor protection concerns that have arisen.

However, some gaps remain in the regulatory system.

• NZX exercises important regulatory functions, supervising two of the most important classes of participants in

organized markets (NZX share brokers and listed companies). It has made significant investments in regulation

since its demutualization. The Securities Commission is encouraged to develop a program for monitoring the NZX’s

continued operational capability and fitness to perform these functions.

• While securities and futures dealers that are exchange members are subject to high entry standards and ongoing

oversight, most other categories of market intermediaries are subject to little or no oversight.

• Minimum standards of conduct for collective investment schemes operators and better reporting mechanisms would

enhance the ability of trustees and private supervisors to monitor collective investment scheme operators.

• There are some weaknesses in standards and penalties relating to market abuse; however, draft legislation to address

these matters is expected in 2004.

Code of Good Practices on Transparency in Monetary and Financial Policies

• The RBNZ exhibits a high degree of transparency in all aspects of its conduct of monetary policy and banking

supervision. The objectives, responsibilities, accountability structures, and transparency obligations are specified in

legislation. The RBNZ issues a wide range of material on a timely basis to explain its performance, including the

quarterly Monetary Policy Statement and Bulletin, post-election briefing papers, and website. The RBNZ issues an

annual report and financial statements, which are subject to external audit and publicly disclosed.

• There is a high degree of transparency in the securities regulatory framework, but its complexities could be better

explained. Each regulator should include on its website a common description of the securities regulatory regime,

outlining its respective roles, responsibilities and interrelationships, with relevant links across agencies’ sites.

Anti-Money Laundering and Combating the Financing of Terrorism

• A team from the Financial Action Task Force (FATF) and the Asia Pacific Group on Money Laundering (APG) is

assessing observance of FATF’s Principles for Anti-Money Laundering and Combating the Financing of Terrorism

(AML/CFT). A summary assessment will be forwarded separately to the Board when completed.

- 29 - ANNEX

SUMMARY ASSESSMENT OF OBSERVANCE OF THE BASEL CORE PRINCIPLES

A. General

60. This assessment of the Basel Core Principles for Effective Banking Supervision

(BCP) was conducted during October and November 2003 onsite in New Zealand. The

BCP assessment was undertaken within the framework of the FSAP for New Zealand.

61. The assessment is based on several sources: (i) a comprehensive self-assessment by

the New Zealand authorities; (ii) detailed interviews with staff from the Reserve Bank of

New Zealand; (iii) laws, regulations and other documentation on the supervisory framework

and on the structure and development of the New Zealand banking sector; (iv) interviews

with staff from the Australian Prudential Regulatory Authority; and (v) meetings with

officers and directors of individual banking institutions as well as with members of the

auditing profession. The assessors benefited from the full cooperation of the New Zealand

authorities and received all necessary information.

62. The New Zealand financial system is dominated by the banking sector, which

comprises 18 registered banks holding assets exceeding $NZ 200 billion (about 160

percent of GDP). The banking sector is, in turn, dominated by 5 systemically important

institutions, all Australian-owned, holding nearly 90 percent of the sector’s assets and

deposits. Only two, smaller banks are New Zealand-owned, including a recently-formed

retail bank that is owned by the New Zealand Post Office which enjoys an explicit guarantee

from its parent. This is the one exception to the strong “free-market” approach generally

espoused by the authorities.

63. New Zealand’s banking sector is profitable and well-capitalized. Over the last five

years, aggregate industry return on assets has exceeded 1½ percent, and after-tax returns on

equity have consistently exceeded 20 percent. Capitalization, whether measured by

equity-asset ratios or regulatory capital measures, is above international minimum prudential

benchmarks. Impaired assets are low, comprising only slightly more than 0.5 percent of bank

assets. General and specific provisions cover about three-quarters of total impaired and

overdue assets.

64. The general preconditions are substantively met. New Zealand accounting

standards, for example, are consistent with international best practice and New Zealand has

announced its intention to adopt International Accounting Standards (IAS) with effect from

January 1, 2007. There will be scope for early adoption from January 1, 2005.

65. The legal framework for bank supervision appears robust. The RBNZ Act

provides a range of powers to address both compliance and safety and soundness concerns

This assessment was prepared by Michael Ainley (U.K. FSA) and Barbara Baldwin

(IMF/MFD).

- 30 - ANNEX

that may arise with respect to a bank. While the powers of day-to-day supervision fall

completely within the RBNZ’s purview, the consent of the Minister of Finance is required to

invoke certain “crisis management” powers. In theory, this could hinder the Reserve Bank’s

ability to apply its enforcement powers promptly but, in practice, there is no evidence of any

political (or industry) interference in the ongoing supervision of banks.

66. Self-discipline, in the form of clear Directors’ responsibilities (see below), and

market discipline are cornerstones of the New Zealand approach to banking

supervision and strongly reinforce regulatory discipline. Banks are subject to

comprehensive disclosure requirements. The regime requires frequent public reporting by

banks, and financial statements must be audited twice annually (though audits of mid-year

statements are limited in scope).

67. Banking supervision in New Zealand is focused on systemic goals. Unlike many

other jurisdictions, New Zealand regulators do not carry any duty to protect individual

depositors, or to safeguard individual institutions. There is no official deposit protection

scheme. The Reserve Bank is empowered to act as a lender of last resort when needed to

ensure the soundness of the financial system, but the RBNZ Act is not prescriptive in how

this responsibility is to be carried out. The Reserve Bank is currently reviewing its crisis

management arrangements.

B. Main Findings—Summary

68. Objectives, Autonomy, Powers, and Resources (CP1): The framework for the

supervision of banks is sufficiently robust. The RBNZ Act specifies that the Reserve Bank

has sole responsibility for bank registration and supervision. It sets out regulatory objectives

and principles, and provides broad rulemaking powers. Systems are in place to ensure that

the RBNZ’s activities are carried out in a transparent manner. Information on the financial

strength and performance of the banking industry is publicly available. Formal funding

arrangements are in place through five-year agreements negotiated between the Governor

and the Minister of Finance. The funding agreement has not yet acted as a constraint on the

RBNZ’s ability to carry out its functions, and it includes a clause that requires the agreement

to be reviewed in the event that there are any material changes in the nature or extent of the

work undertaken by the RBNZ in respect of any of its designated functions.

69. The RBNZ has at its disposal a broad spectrum of tools to carry out routine

supervision and corrective action as necessary. Some tools, such as the ability to

commission or conduct onsite reviews, could now be implemented, selectively, to improve

the effectiveness of the supervisory framework. As already noted, use of certain crisis

management powers must be approved by the Minister; some of the “middle range” powers

in this group, such as the giving of directions to a bank, might more appropriately be placed

directly under the Reserve Bank’s powers.

70. Licensing and Structure (CPs 2-5): There are clear restrictions surrounding the use

of the word “bank” and its derivatives. However, the business of banking is not regulated per

se, and deposit taking is not restricted to banks. Nonbank financial institutions which accept

- 31 - ANNEX

deposits are subject to much less comprehensive registration requirements than banks. This

would appear to create the potential for confusion among consumers of financial services,

though the authorities maintain that the public has been well educated about the different

categories of financial institutions. There are no laws or regulations that define permissible

types of acquisitions and investments for registered banks, and banks are not required to

obtain supervisory approval for acquisitions or even to notify the Reserve Bank of such

events. Although it would be possible to introduce a condition of registration requiring

supervisory approval for specified types of acquisitions and investments, this is viewed as

inconsistent with the RBNZ’s philosophy of supervision. The RBNZ has recently

strengthened regulations governing changes in bank ownership, and are currently considering

enhancements to the fit and proper principles applicable to bank owners.

71. Prudential Regulations and Requirements (CPs 6-15): Although the RBNZ has the

authority to set prudential regulations on a range of issues, it has done so only selectively. At

present, there are explicit rules governing capital adequacy and connected lending. For the

other risks addressed in this set of principles, the authorities underscore that management of

these matters is the responsibility of bank directors, who are best-placed to understand the

individual institution’s risk profile and appetite and to design and implement risk

management systems accordingly. The director attestations and audited disclosure

requirements have contributed to a quite extensive system of checks and balances within the

major banks. While this approach works effectively for certain of these principles, delivering

the underlying objectives (including CPs 8 and 14), it appears less effective, even when

complemented with annual consultations with bank management, in the areas of credit (CP 7)

and risk management (CPs 12 and 13). The RBNZ’s role in the area of money laundering

should be reviewed as part of the current intergovernmental examination of anti-money

laundering measures.

72. Methods of Ongoing Supervision (CPs 16-20): In keeping with its supervisory

philosophy, the Reserve Bank does not conduct onsite inspections of banks. It has the ability

to commission independent, onsite reviews under Section 95 of the RBNZ Act, but has not

yet made regular use of these powers. It is now actively considering doing so. Its offsite

supervision program is more conventional, but here too is limited essentially to receiving and

analyzing information that is available to the general public. More up-to-date “early

warning” information from banks, including liquidity, would strengthen the Reserve Bank's

day-to-day supervision. The Reserve Bank does closely monitor banks’ compliance with

disclosure requirements, and regularly requires corrective action in the form of a revised

statement or subsequent amendment in the event of errors or omissions. The Reserve Bank

also retains the right, used periodically, to request additional information or more frequent

reporting if considered necessary for supervisory purposes; this can extend to information

regarding associated persons or affiliates of the bank.

73. Information Requirements (CP 21): Quarterly public disclosure of comprehensive

financial information on registered banks is a central component of the RBNZ’s approach to

supervision. Local accounting standards are generally consistent with international best

practice, and New Zealand has announced its intention to adopt International Accounting

Standards with effect from January 1, 2007.

- 32 - ANNEX

74. Formal Powers of Supervisors (CP 22): The RBNZ has a range of supervisory tools

to effect corrective action in cases where banks fail to meet prudential requirements or where

depositors are threatened in any other way. A “hierarchy of supervisory response” has been

established, involving procedures for elevating supervisory enforcement matters within the

Reserve Bank if informal approaches prove unsuccessful. As already mentioned, the Minister

of Finance would have to approve the use of certain “crisis management” powers specified in

the Act.

75. Cross Border Banking (CP 23-25): The RBNZ is empowered to undertake globally

consolidated supervision, and the RBNZ Act facilitates the sharing of supervisory

information by providing the necessary confidentiality. Banks are supervised on a

consolidated basis, and this would apply to any overseas branches or subsidiaries, but New

Zealand-incorporated banks currently have no material international operations.

C. Recommended Action Plan and Authorities’ Response

Table 1. Recommended Action Plan to Improve Observance

the Basel Core Principles

Reference Principle Recommended Action

Powers to Address Safety and Soundness Concerns

and Remedial Measures (CPs 1 and 22)

Finalize a crisis-management strategy. Explore possible forms

of cooperation with the Australian authorities, as appropriate.

Permissible Activities (CP 2) The ability of nonbank institutions to accept deposits does

create a potential loophole for regulatory arbitrage, and this

matter should be kept under review in light of reputational risk

issues.

Credit Policies (CP 7) Consider selective and focused use of Section 95 powers to

verify banks’ credit procedures and controls. This could take

the form of an independent third-party report. Alternatively the

Bank could establish its own small risk review team to carry ou

such reviews. This would probably require the Act to be

amended to give the Bank the explicit power to carry out

routine on-site inspections.

Large Exposures (CP 9) Consider obtaining more frequent data directly from the banks.

This could form part of a set of early warning prudential

indicators, which could also include liquidity.

Market Risks (CP 12) As CP 7.

Other Risks (CP 13) As CPs 7 and 9. In these areas, the information which the

RBNZ gets from disclosures and consultations needs to be

supplemented, as it is not comprehensive or current.

Money Laundering (CP 15) The RBNZ’s role in this area should be reviewed as part of the

current intergovernmental examination of anti-money

laundering measures.

On- and Off-Site Supervision (CP 16) Off-site work could be complemented by setting up a specialist

risk-review team for themed visits to banks and by up-to-date

early-warning indicators (CPs 7 and 9 above).

- 33 - ANNEX

Authorities’ response

76. The RBNZ provided the following response to the assessment.

77. “The RBNZ believes that New Zealand has a strong banking system and a framework

of supervision which suits its circumstances well. The framework is based on some

foundations which distinguish New Zealand, to some extent at least, from many other

countries:

• The primary goal of supervision is systemic stability and not depositor or creditor

protection.

• The RBNZ has an explicit duty to pursue efficiency as well as soundness.

• Supervisory methods are aimed as far as possible at strengthening the incentives for

prudent behavior, by encouraging strong governance within banks and market disciplines,

and as a consequence detailed and prescriptive rules are kept to a minimum.

These features inevitably lead to some differences in the way some things are done in New

Zealand compared with the situation in other countries. New Zealand generally places

relatively more emphasis on giving responsibility and accountability for risk management to

banks and their directors, and to auditors and other external reviewers, and relatively less

emphasis on direct oversight by the supervisor. The Reserve Bank of New Zealand thinks

this suits policy objectives and the New Zealand context well.

78. The compliance assessment acknowledges that the New Zealand approach has

genuine strengths, that disclosure continues to provide a discipline on banks and that

attestation requirements are taken seriously by directors, but notes that the approach adopted

leaves some potential or actual gaps.

79. The RBNZ’s view is that all of the high-level Basel Core Principles are addressed

within the New Zealand framework, but not always in a conventional manner. Our decisions

to use alternative methods have been conscious and we believe that those methods are

generally effective. Nevertheless, we acknowledge some of the potential gaps in the

supervisory framework identified by the assessors. We either already have work underway

or plan to carry out work soon on ways of addressing these gaps. For example, work on

crisis management strategies and capacity, and on increased co-operation with Australian

authorities, has been underway for some time. Over the coming year we also will be looking

at making greater use of our powers to require banks to undergo independent reports on key

matters of prudential interest, at whether policies relating to the role of directors and auditors

need to be bolstered, and at whether there is a need to supplement information in disclosure

statements with additional reporting to the supervisor. Disclosure requirements are reviewed

periodically to ensure that they continue to reflect global best practice; further reviews are

planned.

80. Overall, the RBNZ remains satisfied that our basic approach to supervision is

appropriate for New Zealand’s current circumstances, but we accept that some refinements

are needed to ensure that it would continue to be effective in a less benign economic

environment.”

- 34 - ANNEX

SUMMARY ASSESSMENT OF OBSERVANCE OF THE IMF’S CODE OF GOOD PRACTICES

ON TRANSPARENCY IN MONETARY AND FINANCIAL POLICIES

TRANSPARENCY OF MONETARY POLICY

A. General

81. The assessment of practices relating to monetary policy within the framework of

the IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies

was based mainly on the detailed self-assessment prepared by the RBNZ. The

assessment also entailed a review of the relevant documents maintained on the RBNZ’s

website, including the Annual Report, the Bulletin, the Policy Targets Agreement, the

Monetary Policy Statement, the Reserve Bank of New Zealand Act 1989, Agency Agreement,

Operational Guidelines of the RBNZ, amongst others. In addition, discussions were held with

members of the Bank staff, commercial banks and other financial market participants.

B. Main Findings—Summary

82. The RBNZ exhibits a high degree of transparency in all aspects of its conduct of

monetary policy. The broad objectives, responsibilities, accountability structures, and

transparency obligations are specified in legislation. The RBNZ issues a wide range of

material on a timely basis to explain its performance across its functions, including the

quarterly Monetary Policy Statement and Bulletin, post-election briefing papers, and website.

The RBNZ issues an annual report and financial statements, which are subject to external

audit and publicly disclosed.

83. Clarity of roles, responsibilities and objectives of monetary policy: Under the

Reserve Bank of New Zealand Act 1989 (the Act)—which constitutes the RBNZ and

governs monetary policy in New Zealand—the sole objective of monetary policy is the

achievement and maintenance of stability in the general level of prices. This objective is

operationalized by way of a Policy Targets Agreement (PTA) entered into between the

Minister of Finance and the Governor of the RBNZ. The PTA specifies the precise policy

target to which monetary policy is to be directed. The PTA is a public document and is

accessible on the RBNZ website. As part of the governance arrangements applicable to

monetary policy, the objectives and conduct of monetary policy are required by the Act to be

transparent.

84. In addition to its monetary policy functions, the Bank’s other functions are also

contained in the Act. These include: the power to deal in foreign exchange (Section 16); the

power to temporarily suspend foreign exchange business (Section 22); the duty to advise the

Minister of Finance/Treasurer on foreign exchange matters (Section 23); the duty to manage

foreign exchange reserves (Section 24); the sole right to issue currency in New Zealand

This assessment was prepared by Jodi Scarlata, (IMF/MFD).

- 35 - ANNEX

(Section 25); the power to act as lender of last resort (Section 31); the duty to give financial

sector policy advice to the Minister of Finance/Treasurer (Section 33); the power to maintain

securities registry services (Section 35); and the power to register and supervise banks

(Section 67 and various sections in Part V of the Act).

85. The procedures for appointment, terms of office, and any general criteria for

removal of the heads and members of the governing body of the central bank are

clearly specified in legislation. Overdrafts by the government are permitted by the Bank.

The details of the terms under which any overdraft is advanced are not generally disclosed,

but the Agency Agreement between the Government’s Debt Management Office and the

Reserve Bank will shortly be placed on the Bank’s website. While the amounts of advances,

credits and overdrafts to the Government are disclosed monthly on the RBNZ website, there

is no disclosure of the terms of these transactions. It is recommended that the terms of these

advances and overdrafts be disclosed.

86. Open process for formulating and reporting monetary policy: The Act requires the

RBNZ to report publicly on its performance in various ways, including via publication of an

Annual Report and in Monetary Policy Statements. In practice, the RBNZ issues a wide

range of material to explain its performance across its functions, including articles in the

Bulletin, post-election briefing papers (issued immediately after a general election has been

held) and in various publications on the RBNZ website. Section 15 of the Act requires the

RBNZ to issue a Monetary Policy Statement at least every six months to explain its monetary

policy decisions and set out its thinking on possible future economic developments relevant

to inflation. The RBNZ has had a long-standing practice of issuing these statements

approximately every quarter, rather than six monthly. The RBNZ includes comprehensive

medium-term economic forecasts in the MPS.

87. The Governor and other senior RBNZ staff generally give seminars to business

audiences immediately following the release of a Monetary Policy Statement, to explain

the RBNZ’s monetary policy decision and related issues. The Governor also makes

numerous speeches throughout the year explaining monetary policy and other issues relevant

to the RBNZ’s functions. Other senior staff also give occasional presentations to various

external audiences.

88. Public availability of information on monetary policy: While New Zealand has not

yet applied to subscribe to SDDS, for several years central bank data have complied with

SDDS standards in all significant respects. A forward release calendar is disseminated on the

Bank’s website for a range of central bank data that corresponds to the subset specified by

SDDS. All of these data are disseminated with coverage, periodicity and timeliness

parameters that meet SDDS standards.

89. A summary statement of financial position is issued on the Bank’s website at a

specified date each month. The timing of the release is publicly disclosed. The statement

discloses information on aggregate market transactions and key balance sheet items.

- 36 - ANNEX

90. The RBNZ maintains an active public information service. In addition to a

detailed website, www.rbnz.govt.nz, the following documents are also published: RBNZ

Annual Reports and Monetary Policy Statements; post-election briefing paper—the most

recent one being issued in August 2002; RBNZ Bulletin—issued quarterly; RBNZ

Discussion Papers—issued on an ad hoc basis; speeches by the Governor and other senior

staff; brochures and pamphlets issued by the RBNZ (including on the functions and structure

of the RBNZ and on issues relevant to understanding its functions).

91. Accountability and assurance of integrity by the central bank: The Governor and

other RBNZ officials can be required to appear before Parliament’s Finance and Expenditure

Committee. This generally occurs four or five times a year, typically after the release of each

Monetary Policy Statement and Annual Report. The Committee occasionally conducts fuller

enquiries into the RBNZ’s operations (as it does for many government agencies).

92. The RBNZ is required to prepare and publish comprehensive financial

statements which comply with accepted accounting practices. The financial statements,

accounting policies and systems, and internal controls are subject to annual external audit. In

addition, the Act empowers the Minister of Finance to engage an external party to review

other aspects of the RBNZ’s operations as he or she sees fit.

93. The Act contains a number of provisions relating to the conduct of personal

financial affairs of directors and staff of the Bank, including rules relating to conflicts

of interest; it provides legal protection to directors and staff of the Bank, stating that they

shall only be personally liable for exercising powers conferred by the Act in bad faith or

omitting in bad faith to exercise a power conferred by the Act; and it makes provision for the

Government to indemnify the RBNZ, officers or employees of the RBNZ, statutory managers

of registered banks, among others, for liability arising from exercising powers or omitting to

exercise a power conferred by the Act.

C. Recommended Action Plan and Authorities’ Response

Table 2. Recommended Action Plan to Improve Observance of IMF’s MFP Transparency

Code PracticesMonetary Policy

Reference Practice Recommended Action

Practice 1.2.1 The details of the terms under which any overdraft is

advanced should be disclosed.

Practice 1.2.2 Disclosure should be made of all relevant details of the

amounts and terms of credits, advances or overdrafts

provided to central government by the Bank, and the terms

and conditions of government deposits with the Bank

Authorities’ response

94. All comments by the authorities have been incorporated and they are in

agreement with the assessment.

- 37 - ANNEX

TRANSPARENCY OF BANKING SUPERVISION

D. General

95. The assessment of transparency in banking supervision was based on a detailed

self-assessment prepared by the RBNZ, a review of the relevant documents maintained on

the RBNZ’s website, and discussions with members of the RBNZ staff, commercial banks

and other market participants.

E. Main Findings—Summary

96. Clarity of roles, responsibilities and objectives: The RBNZ is the sole authority

responsible for registering and supervising banks, and has no supervisory jurisdiction over

other categories of financial institution. The RBNZ Act 1989 (the Act) sets out the RBNZ’s

functions, powers, accountability structures and transparency obligations. The RBNZ has

responsibilities in a range of financial system areas, including: the registration and

supervision of banks; responding to financial distress events affecting registered banks;

acting as lender of last resort; providing advice to the government on the operation of the

financial system; coordinating and promoting legislative change in areas that relate to

banking; and overseeing and operating the payment system. All of these functions are

disclosed and explained publicly, including in the RBNZ’s Annual Report, on the RBNZ

website, in brochures and in the RBNZ Bulletin.

97. An MOU between the domestic regulatory agencies is being developed and is

expected to be publicly disclosed. The RBNZ has publicly referred to the nature of the

financial sector regulatory framework, including the nature of cooperation between

regulatory agencies. This information is presented on the RBNZ website.

98. Open process for formulating and reporting financial policies: The Act requires the

RBNZ to explain its approach to implementing policy, which is to be done in the case of

bank registration and supervision by the issuance of a Statement of Principles. The Act

requires the RBNZ to report publicly on its performance in various ways, including via

publication of an Annual Report. In practice, the RBNZ issues a wide range of material to

explain its performance across its functions, including articles in the quarterly Bulletin, post-

election briefing papers, and in various publications on the RBNZ website.

99. The RBNZ Board is required to keep the RBNZ’s and Governor’s performance

across all the RBNZ’s functions under constant review. The Board comprises non-

executive directors appointed by the Minister of Finance (including the Governor) and is

chaired by a non-executive director. Under the Act, the Board is required to issue an annual

report on its assessment of the RBNZ’s and Governor’s performance, and the report is

publicly released. The Board periodically meets with the Minister of Finance and is required

by the Act to report to the Minister any concerns it may have in relation to the RBNZ’s or

Governor’s performance.

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100. Public availability of information on financial policies: The RBNZ publicly releases

a number of documents in the area of banking supervision, either in hard copy or on the

website. Part V of the RBNZ Act contains all of the relevant powers and responsibilities for

the RBNZ in the area of registration and supervision. The RBNZ Annual Report provides an

overview of the RBNZ’s functions and broad indicators of performance by function, while

the banking supervision handbook contains the Statement of Principles and all prudential

regulations. Regular articles published in the RBNZ Bulletin on the state of the banking

system summarize developments in banking supervision.

101. Accountability and assurance of integrity: The Governor and other RBNZ officials

can be required to appear before Parliament’s Finance and Expenditure Committee. This

generally occurs four or five times a year, typically after the release of each Monetary Policy

Statement and Annual Report. The Committee occasionally conducts fuller enquiries into the

RBNZ’s operations, but rarely discusses the RBNZ’s financial stability functions in any

detail.

102. The RBNZ is required to prepare and publish comprehensive financial

statements which comply with accepted accounting practices. The financial statements,

accounting policies and systems, and internal controls are subject to annual external audit. In

addition, the Act empowers the Minister of Finance to engage an external party to review

other aspects of the RBNZ’s operations as he or she sees fit.

F. Recommended Action Plan and Authorities’ Response

Table 3. Recommended Action Plan to Improve Observance of IMF’s MFP Transparency

Code PracticesBanking Supervision

Reference Practice Recommended Action

Practices 5.2 and 6.1.5 Details of the MOU between domestic regulatory agencies

should be made public.

Authorities’ response

103. All comments by the authorities have been incorporated and they are in

agreement with the assessment.

TRANSPARENCY OF SECURITIES REGULATION AND SUPERVISION.

G. General

104. The assessment of securities regulation transparency was based on the detailed

self-assessment prepared jointly by the Securities Commission, Takeovers Panel and

Registrar of Companies. The assessment also entailed a review of the relevant documents

maintained on the agencies’ respective websites, discussions held with members of the staff

of the aforementioned agencies, and other financial market participants.

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H. Main Findings—Summary

105. There is a high degree of transparency in the securities regulatory framework,

but the complexities of the oversight regime are not always well explained. Each

regulator should include on its website a common description of the securities regulatory

regime, outlining its respective roles, responsibilities and interrelationships, with relevant

links across agencies’ sites. In addition, it would be helpful if legislation was accessible in its

entirety, as opposed to by articles and sections only.

106. Clarity of roles, responsibilities and objectives: The financial agencies responsible

for implementing securities regulation in New Zealand are the Securities Commission (SC),

the Office of the Registrar of Companies, and the Takeovers Panel (TP). The Securities Act

establishes SC, defines its powers and functions, regulates the offer of securities to the

public, and confers on ROC the responsibility of registering prospectuses and associated

documents for the offer of securities to the public. The Securities Markets Act enacts rules

about insider trading, disclosure by public issuers, substantial security holder disclosure,

disclosure of dealings by directors and officers of public issuers, registration of exchanges,

and dealings in futures contracts. It confers on SC the power to regulate in these areas. The

Takeovers Act provides for the establishment and constitution of TP, the enactment of a

Takeovers Code, and the regulation of company takeovers. The Companies Act contains

rules of law about the incorporation, constitution and administration of companies. It

establishes the ROC and confers regulatory powers on the holder of that office.

107. The procedures for appointment, terms of office and criteria for removal of

officials are specified in the relevant legislation; however, for the ROC, the terms limits

and criteria for removal exist only insofar as ROC falls within the State Sector Act and there

are no detailed specifications for officials of the ROC. The relationship between the SC and

the TP is set out in the functions of the Commission in the Securities Act. Elements of the

relationship between the SC and NZX are publicly disclosed and there are MOUs in force

between the SC and NZX and between SC and TP which are also made available to the

public. The SC, ROC and the banking prudential regulator, the RBNZ, meet quarterly as the

Financial Regulators’ Coordination Group. The agencies all have websites in which their

operations and relationships are described. The Group comprises the RBNZ, Takeover Panel,

Securities Commission, Ministry of Economic Development, Government Actuary, Registrar

of Companies, Official Assignee for New Zealand, Serious Fraud Office, and Commerce

Commission. An MOU between the domestic regulatory agencies is being developed and is

expected to be in place before the end of 2004, at which point it will be publicly disclosed.

108. Open process for formulating and reporting financial policies: SC is empowered to

publish a report or a comment made in the exercise of its functions, and makes extensive use

of this power. The Official Information Act applies at the end of the inquiry, so that any

member of the public may request access to information held by SC. The Ombudsman acts as

appeal authority in respect of any request declined. SC regularly issues and publishes policy

and practice guidance, both on its website and in its quarterly bulletin.

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109. TP is subject to the Official Information Act. TP must give reasons for granting an

exemption and these must be published although it may defer or omit publishing in particular

cases on the ground of commercial confidentiality. Transparency is required in respect of its

inspection and inquiry work. The TP’s policies for administering key sections of the Code

are published and explained. The Panel discloses its regulatory framework, and aspects of its

operating procedures via its website, press releases, annual report and Code Word. The Panel

widely publicizes its decisions and the reasons accompanying them within a legally specified

timeframe.

110. Financial policies affecting securities regulation are subject to extensive prior

consultation with affected parties, whether contained in statutory regulations, financial

reporting standards, exchange rules or policy statements of a financial agency. The

agencies are required to act independently in formulating new policies, as expressed in the

Output Agreement with the Minister of Commerce. Policy changes are published and subject

to notice and comment requirements.

111. Public availability of information on financial policies: The TP and SC maintain

active programs of communication with the investment community and the general public,

including annual reports and quarterly bulletins. The SC uses its extensive powers of

comment to report on the application of the law. The RC, through the Companies Office

publishes an annual report detailing the activities of the Companies Office. The government

agencies report extensively on their financial and service performance and significant

regulatory action taken in their annual reports.

112. Accountability and assurance of integrity: Officials of all Crown entities are

required, when asked, to appear before the responsible Parliamentary Committee. The

primary context for a request will routinely be the entity’s annual budget or annual report but

Committee Members can be expected to ask a very wide variety of questions about policies,

objectives, activities, performance, quality of regulation and state of the markets. Select

Committees have powers to obtain information, and to request and require attendance of

persons.

113. The ROC, TP, SC must all prepare financial statements that comply with GAAP

and which are audited by independent auditors. The Auditor-General is required to audit

the financial statements prepared by the SC and TP and must express an independent opinion

on the financial statements and report that opinion to the public. The Commission’s annual

report must be presented to the House of Representatives. Internal governance procedures

and conflict of interest guidelines are described in the establishment laws and annual reports.

The legal protections for members and staff of SC and TP are stated in the establishment

laws and protects from liability those persons exercising powers of inspection under the Act.

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I. Recommended Action Plan and Authorities’ Response

Table 4. Recommended Action Plan to Improve Observance of IMF’s MFP Transparency

Code PracticesSecurities Regulation

Reference Practice Recommended Action

Practice 5.1 Provide an overall description of securities regulation (i.e.,

the responsible agencies, their roles, interrelationships, etc)

in one unified format on the websites as well as linkages

across websites of the relevant agencies.

The ROC website, embedded within that of the MED,

might be made more accessible and user friendly.

Make legislation available in its entirety (as opposed to

section by section)

Practice 5.2 The MOU should be placed on the websites of all relevant

regulatory bodies.

Practice 6.1.5 All MOUs should be made publicly available, unless

sensitivity requirements necessitate otherwise.

Authorities’ response

114. The relevant agencies have provided comments on the above assessment, which have

been duly incorporated, and they are in agreement with the overall assessment.

SUMMARY ASSESSMENT OF OBSERVANCE OF THE IOSCO OBJECTIVES AND PRINCIPLES OF

SECURITIES REGULATION (IOSCO PRINCIPLES)

A. General

115. This assessment is based on the authorities’ self-assessment; a review of relevant

laws, procedures and publicly available information concerning the authorities, the New

Zealand Securities Exchange (NZX) and the New Zealand Futures and Options Exchange

(NZFOE); and interviews with the authorities and market participants. The assessment used

the Methodology for Assessing Implementation of the IOSCO Objectives and Principles of

Securities Regulation adopted by IOSCO in October 2003.

116. New Zealand markets have been undergoing significant change. NZX

demutualized in late 2002, self-listed in 2003, and recently launched a new, regulated market

targeted at developing and non-traditional enterprises. SFE Corporation (SFE), NZFOE’s

parent corporation, will transfer trading in NZFOE products to Australia in 2004 and has

This assessment was prepared by Janet Holmes (Ontario Securities Commission).

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entered into a deal with NZX for the trading on SFE of products based on NZX-listed

securities.

117. The SC is the principal statutory regulator, while the TP and RC have more

narrowly defined roles. The Ministry of Economic Development (MED) is involved in

policy development, while NZX exercises self-regulatory functions. NZX firms and their

associated brokers are the most significant class of market intermediaries operating in

organized equity markets, while most secondary market trading in New Zealand public

companies involves issuers listed on NZX (or an overseas market).

B. Main Findings—Summary

118. Recent reforms and NZX’s restructuring have strengthened the securities

regulatory framework. The authorities are aware, however, that additional reforms are

needed to fully implement the IOSCO Principles, and have committed to introduce them.

119. Principles Relating to the Regulator (1-5): Although the regulatory scheme is

complex, each regulator’s functions and powers are transparently set out in legislation, as

well as websites or other publications. Structures exist to ensure that the regulators achieve

high standards of procedural fairness and remain accountable. The SC and TP are

operationally independent, while the RC is expected to exercise decision-making powers

independently. Although the regulators do not have adequate powers to fully implement all

the IOSCO Principles, generally they are fulfilling their existing mandates and exercising

effectively the powers they have. Furthermore, the Government has shown its willingness to

provide requested funding to enable the regulators to fulfill their increasing responsibilities.

120. Principles of Self-Regulation (6-7): The regulatory system places substantial reliance

upon SRO-type functions performed by regulated exchanges. Since NZX's demutualization,

its management has been investing more in regulatory functions. The SC and Minister assess

a securities exchange’s willingness and legal capacity to carry out SRO-type functions as part

of the exchange registration process, but do not assess the adequacy of the exchange’s

resources or of its operators’ integrity and fitness. There is some ongoing oversight of

registered securities exchanges. The SC interacts regularly with NZX, both formally under a

Memorandum of Understanding (MOU) and informally. There is, however, no formal

oversight plan for NZX.

121. Principles for Enforcement (8-10): The SC, TP, and NZX have very broad

inspection, investigation and surveillance powers. These powers enable it to exercise a

greater degree of oversight than might otherwise be the case in a regulatory scheme, like

New Zealand’s, that does not provide for comprehensive supervision of market

intermediaries. Collectively, the regulators also have a relatively wide and flexible range of

enforcement tools. The regulators have shown their willingness to respond promptly to

concerns by undertaking inquiries, taking enforcement action, or referring the matter to the

appropriate authority.

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122. Principles for Cooperation (11-13): The SC can and does share information with

other domestic authorities without the need for external approval. Each of the securities

regulators, MED, NZX and NZFOE can enter into information-sharing agreements, and

several agreements have been or are in the process of being executed. There are also close

informal ties between the SC and other securities regulators. The SC signed the IOSCO

Multilateral Memorandum of Understanding in October 2003. The SC’s powers, capability

and willingness to cooperate with overseas regulators were subjected to a rigorous screening

process by a team of IOSCO experts before it was accepted as a signatory.

123. Principles for Issuers (14-17): There are comprehensive disclosure requirements for

public issuers’ offer documents, which are reviewed by the RC and in the case of NZX listed

companies, by NZX as well. The SC can prevent an offering from continuing if the offering

documents or related advertisements are misleading. The Government has provided

additional funding to the SC to develop criteria for risk-based reviews of disclosure

documents and intends to introduce legislation in 2004 to enhance the regulators’ powers to

enforce disclosure standards for offerings. The continuous disclosure requirements applicable

to listed companies provide for sufficient, timely disclosure. Unlisted issuers, however, are

required to report financial results only once a year and do not have to submit audited, annual

financial statements to the RC until almost six months after year-end.

124. Accounting standards are of a high and internationally acceptable quality.

Accounting standards are approved by the Accounting Standards Review Board (ASRB), an

independent Crown entity that is accountable to Parliament through the Minister. The ASRB

has recommended that all New Zealand entities should be required to adopt International

Financial Reporting Standards commencing in January 2007. The Institute of Chartered

Accountants of New Zealand (ICANZ) is an SRO that develops and enforces auditing

standards. ICANZ decisions are subject to judicial review, but its interpretation processes are

not subject to the oversight of a regulator or other body acting in the public interest. MED’s

review of the Financial Reporting Act, however, is expected to include a review of audit

standard-setting, and the SC-led corporate governance project has now been finalized and

published (Corporate Governance in New Zealand – Principles and Guidelines).

125. Principles for Collective Investment Schemes (17-20): The marketing of collective

investment schemes (CIS) is subject to comprehensive disclosure requirements applicable to

all public offers of securities. CIS also must file audited annual financial statements. CIS are

operated within a framework of trust law, which requires CIS operators to act with due care

in the unit holders’ best interests. Since many matters are negotiated between the CIS

operator and its trustee or supervisor, there can be significant variations in investor

protections across various schemes. Although there is no program for ongoing regulatory

oversight of CIS operators or their trustees or supervisors, the SC and other regulators

exercise their inspection and enforcement powers to deal with problems arising in respect of

certain operators.

126. Principles for Market Intermediaries (21–24): Firms and brokers who participate

directly in regulated markets in New Zealand are subject to comprehensive entry standards

assessed by the relevant exchange. These market intermediaries also must comply with the

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exchange’s prudential requirements and standards for internal organization and operational

conduct. NZX has implemented a pro-active compliance program for NZX firms. Most other

market intermediaries are subject to few entry standards or ongoing standards of conduct, and

are not subject to regular supervisory oversight. The securities law reform commencing in

2004 is expected to involve a comprehensive review of the regulatory scheme for market

intermediaries.

127. Principles for Secondary Markets (25-29): A market cannot hold itself out as a

securities exchange (or futures exchange) unless it obtains registration (authorization) from

the Minister or SC, respectively. Otherwise, a market can operate without registration

(authorization) unless the Minister requires the market to obtain registration (authorization)

or cease carrying on business. The registration process does not provide for an assessment of

the market operator’s competence, sufficiency of resources or integrity. The SC has broad

powers to inquire into the affairs of regulated and unregulated markets.

128. Although general fraud and consumer protection laws can be used to address

some forms of manipulative or unfair practices relating to securities, securities

legislation does not expressly prohibit market manipulation, the dissemination of

misleading information (except in respect of offers) or front running, and provides only for a

civil cause of action and a civil penalty in respect of insider trading. NZX and NZFOE have

rules prohibiting, and systems to detect, illegal, manipulative and deceptive conduct on its

markets, and work closely with the SC to address concerns that arise. Furthermore, the

Government intends to introduce legislation in 2004 providing for reform of the securities

trading law, including the establishment of criminal and civil penalties for these activities.

129. NZX appears to have developed appropriate procedures to monitor and address

large exposures, default risk and market disruption. Formal and informal arrangements

exist to enable market operators, regulators, other relevant domestic authorities and overseas

authorities to share information on large exposures of market participants.

C. Recommended Action Plan and Authorities’ Response

Table 5. Recommended Action Plan to Improve Observance of the IOSCO Principles

Reference Principle Recommended Actions

Principles 7, 8, 25

and 26

• Amend legislation to include comprehensive, high level entry and ongoing

standards for regulated exchanges’ integrity, competence, financial capacity,

internal controls, powers and duties.

• The SC should develop a formalized oversight plan for regulated exchanges.

• Amend legislation to enable the SC or the Minister to require a registered

exchange to amend any or all of its conduct rules.

• The NZX should adopt a broader definition of “independence” (applicable to the

individuals constituting the Special Division of its disciplinary body, deciding

matters involving NZX in its capacity as a listed company), or disciplinary

functions in respect of NZX should be transferred to an independent body, such

as the SC.

Principle 9

• Implement the reforms in the remedies and penalties section of the Cabinet

Paper, Investment Advisers.

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Principle 14

• Devote more resources to the review of disclosure documents, so that regulators

can conduct comprehensive reviews of issuers’ disclosure records through risk-

based review systems.

• NZX-listed companies should be required to notify NZX (in confidence) when

they rely on the exemption to make timely disclosure of material developments,

enabling NZX to spot-check appropriate reliance on the exemption and

facilitating surveillance.

• Amend the Financial Reporting Act to provide for more timely disclosure of

annual financial information by unlisted public issuers.

Principle 15 (and 9)

• Amend the companies legislation to supplement existing self-help remedies.

• Amend the securities legislation to require substantial security holders, directors

and officers to file their notices of transactions in a central, public, easily

accessible electronic register.

Principle 16

• ICANZ’s interpretation process should be overseen by a regulator or other body

acting in the public interest.

• Amend the NZX Listing Rules to require immediate disclosure of the

resignation, removal or replacement of an external auditor.

Principles 17-20

• Amend the securities legislation to provide for: (1) greater oversight of

contributory mortgage brokers; (2) high level entry and ongoing standards

concerning CIS operators' honesty and integrity, competence, financial capacity,

internal controls, powers and duties; (3) general conflict of interest standards for

CIS operators and their trustees or supervisors; (4) minimum standards for CIS

operators to provide periodic and timely reports to trustees or supervisors (or to

the appropriate regulator), (5) minimum requirements for trustees or statutory

supervisors to conduct periodic inspections of CIS operators and make timely

reports to the SC of any material contraventions by CIS operators of applicable

standards.

Principles 21-24

• Enact legislation providing for more comprehensive oversight of market

intermediaries that: (1) requires minimum entry standards relating to integrity,

financial capacity, competence, operational capability, internal controls;

(2) requires periodic reports to the regulator or SRO; and (3) enables the

regulator to take effective enforcement action if these standards are not met.

Principle 24

• Securities regulators and SROs should develop a comprehensive crisis

management plan for dealing with the potential failure of market intermediaries.

Principles 27-29

• Amend the securities legislation to specify high level standards for regulated

exchanges’ trading systems and rules with respect to trade transparency, unfair

trading practices, management of large exposures, default risk and market

disruption.

Principles 28 (and 9)

• Implement the Government’s proposed reforms to the securities trading law.

Authorities’ response

130. The New Zealand authorities consider the FSAP mission’s findings and

recommendations helpful, and note that, in many areas, work is already underway to further

improve observance of the IOSCO Principles.

131. The authorities note the FSAP team’s endorsement of the forthcoming law reforms

relating to the introduction of comprehensive prohibitions on market manipulation, insider

trading and enhanced penalties and enforcement powers. The authorities welcome the

constructive technical recommendations designed to improve New Zealand’s observance of

the IOSCO Principles, and will give consideration to them. The team’s suggestions with

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regard to regulatory oversight of market intermediaries and collective investment schemes

will be considered in the proposed reviews of the relevant legislation to be undertaken in the

near future.

132. The authorities note the recommendation that legislation be amended to specify

standards for regulated exchanges’ rules with respect to trade transparency, unfair trading

practices, management of large exposures, default risk and market disruption. The

authorities consider that the broad public interest test in the current legislation provides

flexibility for these things and others to be considered when approving exchange rules, and is

preferable to a prescriptive approach.

133. The Securities Commission has decided to develop a formal oversight plan for

regulated exchanges this year and has informed NZX. It is most likely that details of this

plan, once settled, will be published. The oversight plan will cover some of the matters

identified by FSAP as appropriate “ongoing standards” for regulated exchanges and the

Commission expects to report on its oversight actions.