KEY POINTS:
Moves by the Securities Commission - now introduced by way of an amendment to the securities regulations - to give the trustee companies more power to obtain reports and information from finance companies are a step in the right direction, but will they fully address the problem?
The
answer is no, because apart from cementing in what is already considered best practice, the changes fail to answer the basic question facing investors in finance companies - namely, which ones are sound?
The complicating factor is that it is not the role of the commission to tell people which companies are good investments and which are bad. Its role is to set clear rules and ensure compliance with those rules. Like trustees, the commission can be in a difficult position when the axe starts to fall.
When a finance company starts failing to meet its trust deed responsibilities, its trustee must make a judgment on whether or not to act, knowing that taking action may well be signing the company's death warrant.
Trustees may find themselves exposed to legal action either way - being accused of losing investors' money by pulling the plug too early or of causing losses to new investors by not acting.
These are decisions that can be easily made when one's own money is at stake, but are more difficult when one is a trustee acting for others.
As recent events have shown, confidence is a fragile thing and a lack of it can lead to a run, a cascade of failures and a flight to so-called "security".
It is easy to say that finance companies are a relatively small part of local investment markets. But in practice they meet a real need, often providing funding at the second-mortgage level where banks don't wish to go, delivering consumer finance to those seeking a new vehicle or home appliance, and bridging funding gaps for property developers.
Investor protection is important but it can only do so much in itself.
Education is vital. If people truly understood the risks they were taking, they wouldn't be surprised at losing money from time to time.
In practice, many people putting money into finance companies don't even bother to read the investment statement. They will almost never see the full prospectus and they probably won't have the specialist knowledge to understand it anyway. Instead, they choose the highest rate of interest on offer or leave it to a financial adviser (who may receive a commission from the finance company in question).
Fortunately, there are lessons to be learned from deeper markets in other countries.
The Australian Securities and Investments Commission, in its recent consultation paper on improving disclosure to retail investors, says unlisted and unrated securities pose particular challenges because investors do not have the benefit of market forces showing them the daily value of their investment, or a reliable exit mechanism.
Some finance companies offer early exit options but these are unlikely to be available if the issuer, or indeed the industry, has cash flow issues.
The proposals from ASIC are built on improving disclosure based on four principles, all involving benchmarking and designed to aid investors, their advisers and others to evaluate and compare different finance companies.
The ASIC approach goes beyond the "agency ratings" mechanism that some are advocating here and shows the direction in which the legislators should be moving in New Zealand.
What legislators must not do is create a situation in which the process of raising money from the public becomes so onerous that sound commercial projects face a higher than necessary cost of capital or are starved of investment.
In the war against obesity, there is talk of green, orange and red signals on food packets. Investors don't need a watchdog that does that for them, but they do need to educate themselves and get good quality advice on the risks they are undertaking, preferably from someone who isn't earning an undisclosed commission from the finance company concerned.
* Michael Dineen is a senior partner in national law firm Buddle Findlay.
What ASIC wants:
* Public benchmarks covering ratings, capital, liquidity, lending, loan diversification, valuations, related party transactions and funding roll-overs.
* Disclosure against these benchmarks.
* Issuers, trustees, advisers, valuers and auditors using these benchmarks in carrying out their duties.
* Educating investors on benchmarks.
* An "if not, why not" approach to reporting.
www.asic.gov.au
