Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill

I move, That the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill be now read a first time. I nominate the Finance and Expenditure Committee to consider the bill. At the appropriate time I intend to move that the bill be reported back to the House by 22 July 2019. This will allow the bill to be passed in time to meet deadlines for the relevant international reforms that are driving the amendments in this bill.

This bill amends various pieces of financial markets legislation to bring New Zealand into line with international best practice. Importantly, the bill will also allow New Zealand entities to continue to access important international financial markets. In recent years, various reforms have been introduced internationally to address significant risks in global financial markets. These reforms are intended to reduce risk and improve the integrity of how certain financial contracts are traded and the processes by which they are set. They will help make aspects of the global financial system more resilient and more resistant to manipulation.

The amendments in the bill will bring New Zealand into line with these international reforms and improve the integrity of our financial systems. The amendments in the bill are also critical to ensure New Zealand entities can continue to access important international financial markets. Without these amendments, New Zealand entities would not be able to comply with the relevant requirements imposed by the new reforms, and this would mean that they may not be able to enter into critical financial contracts with international counterparts—for example, the big four banks in New Zealand, directly through their clients, are estimated to have a gross exposure of $1.1 trillion to parties of the European Union through particular types of financial contracts affected by one of the recent international reforms. If New Zealand’s regulatory regime is not brought into line with the new reforms and the banks were shut out of the key international financial markets, the disruption to businesses and the increase in funding costs would have a marked effect. This would not just affect the banks but also see interest rates increase for New Zealand consumers and businesses.

Over the past year, the Ministry of Business, Innovation and Employment (MBIE), the Reserve Bank, and the Financial Markets Authority have undertaken a comprehensive review of what is required to bring New Zealand into line with international reforms. The result is a robust piece of legislation—while technical, it also sets out to improve the integrity of our financial system and resolve what could potentially constitute a significant risk to the New Zealand economy.

The bill has two parts, each of which responds to different international developments. Part 1 of the bill responds to G20 requirements related to over-the-counter derivatives. These requirements were announced in 2011 following the global financial crisis, which identified risks in the market for over-the-counter derivatives, and the requirements are currently being phased in across G20 nations. The global market for over-the-counter derivatives is worth trillions of dollars, and the G20 identified that there were systemic risks in this market. Requirements were therefore introduced for parties to exchange collateral—also known as a margin—to prevent these risks being spread across financial institutions. The G20 rules required this margin to be available immediately in the event that a party defaults under a contract. Certain features of New Zealand’s insolvency law, however, prevented affected entities from complying with these requirements.

This bill will allow New Zealand entities to meet those requirements by making technical amendments to the Reserve Bank of New Zealand Act, the Corporations (Investigation and Management) Act, the Companies Act, and the Personal Property Securities Act. The effect of these amendments is to allow certain qualifying parties to exercise rights over the margin that they hold immediately and to have priority over other parties with an actual or potential claim on that margin. The amendments are tightly confined to limit any potential impact on current insolvency law and non-derivative creditors. Analysis by MBIE and the Reserve Bank has shown that it is very unlikely that these changes will ever disadvantage a party which would otherwise have a priority. They have engaged with New Zealand’s banks and with other interested parties, such as insolvency practitioners’ industry bodies, to ensure that the proposed changes are proportionate and fit for purpose.

Part 2 of the bill responds to a separate international development. The European Union recently introduced a new regulatory regime for financial benchmarks. These benchmarks are referenced in many financial contracts and they underpin important factors such as mortgage interest rates. The intent of the EU benchmarking regime is to avoid potential manipulation of benchmarks and other events which could destabilise national and international markets.

To trade with EU parties, New Zealand needs a financial benchmark regime which the EU formally recognises as equivalent, and one of the ways of achieving this is to require parties that administer financial benchmarks to be licensed and subject to supervision by a regulator. To meet those new EU requirements, Part 2 of this bill amends the Financial Markets Conduct Act to create a licensing regime for New Zealand benchmark administrators. This new regime allows the administrator of a financial benchmark to opt in to obtain their market services licence under the Financial Markets Conduct Act and to meet certain governance requirements. Supervision and enforcement of licence obligations will be carried out by the Financial Markets Authority and detailed licensing requirements will be set in regulations. These requirements will largely reflect what is required by the EU regulations in order for New Zealand’s regulatory regime to achieve formal equivalent status. MBIE has been consulting officials in the EU to ensure that the regime is designed in a way that will meet the requisite standards.

The new licensing regime for administrators of financial benchmarks will do three things. Firstly, it will provide additional assurance around the accuracy, integrity, reliability, and continuity of New Zealand’s benchmarks; secondly, it will ensure continued acceptance of New Zealand’s benchmarks within the EU markets; and, thirdly, it will avoid significant costs to the New Zealand economy that could arise if our benchmarks were not able to be used in the EU.

The licensing regime also provides new powers for the Financial Markets Authority to direct contributors to and administrators of benchmarks to continue to maintain a benchmark for a specific period of time. The purpose of these powers is to ensure the continued reliability and availability of financial benchmarks for a period of time in the case of a potential disruption to that benchmark. Such disruptions may occur when the licensed administrator intends to stop administering a benchmark that is important for trade with EU parties. This will promote market stability while a smooth transition of a benchmark to another administrator or an orderly cessation or generation of a benchmark is being arranged.

These changes are technical. However, this is a critical piece of legislation that will allow major New Zealand financial institutions to continue to transact with important overseas parties in order to manage financial risks, raise capital, and continue to effectively engage in international financial markets. This will bring us into line with international standards and will proactively avoid potentially substantial economic damage. I commend this bill to the House.

Thank you, Madam Assistant Speaker. I rise in support of the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill in this, its first reading, and I congratulate Minister Kris Faafoi for his stamina and endurance. He’s been in the House for quite some time this evening, waiting to deliver that eight-minute speech to the House.

We do support this bill. It relates to linkages between our financial markets and international financial markets, which are a critical source of funding for the lending that New Zealand banks do. We support reforming legislation to achieve the outcomes for this bill because, fundamentally, it’s the only way for us to keep some of these markets open to our banks. It’s important that we don’t have laws that are impeding the access to those international markets, particularly in this specific case of over-the-counter derivatives. They are, therefore, needed to ensure the ongoing soundness and efficiency of our banking systems. Our banks need access to capital, principally, because they need to be able to lend to New Zealanders—New Zealand consumers and businesses. Along with continuing to permit access into EU markets for derivatives, we also support the licensing regime, as well.

It is a simple fact that, in New Zealand, a great deal of our lending is sourced from overseas borrowing. It is a fact that New Zealanders either—well, it leads to the same outcome. Either, they don’t deliberately save sufficiently or they spend so much of their incomes that our banks cannot source the capital they need to permit borrowing from domestic markets alone, so banks will seek to borrow money from offshore. Now, that has a flow-on effect that moneys are often borrowed in multiple currencies, and our banks use derivatives to protect, or to hedge, against exchange rate risk from them borrowing in those foreign currencies.

So it’s a very important—well, the banks would consider it critical for them and, ultimately, it’s most important to New Zealand consumers and businesses, because it’s those dollars, those loans, that they need access to, whether it’s to build the home or buy the home they want to raise their family in, or, indeed, if they are looking to expand their business. Expansion will lead to more people being employed and to more incomes, and therefore, it is of benefit to all those involved. So it’s important to look at this. While talking about the legislation, the language is, principally, about financial markets and banks, but we shouldn’t lose sight of the ultimate beneficiaries of these changes—should they be enacted—and those are New Zealand consumers and New Zealand businesses.

These are being, in effect—shall we say—gently persuaded upon us. These have been forced upon us through changes in international markets. In the case of this first part—the derivatives piece—they are the changes to the G20 rules. So they now require that parties to what they call over-the-counter, uncleared bilateral derivatives provide security—also known as margin—under that contract to support it. If one party fails to honour its obligation under the contract, the other party can call on margin to shield it from any losses that might result, and it’s that certainty that allows the two parties to the contract to enter it with confidence that not only allows the contract to be undertaken in the first place but helps to keep the costs of the contract and then, ultimately, the costs of borrowing to New Zealand businesses and consumers down.

There were some reforms introduced by the G20 as a way of reducing systemic risk as a result of what they’ve learnt from the global financial crisis, particularly in these derivative markets. But there are certain features of our current domestic law—particularly around insolvency, statutory management, and personal property securities laws—that could impede the banks’ ability to comply with the margin requirements, or with these new rules from the G20.

So the option to us, obviously, is we continue to maintain our laws as they currently are, but the most likely consequence of that is either the exclusion to New Zealand banks for these sorts of contracts or, with the uncertainty that might be deemed to exist there, an increased cost of borrowing. The last thing we need to do to New Zealand businesses as we—well, certainly we on this side—seek to wish to continue to grow the economy, grow jobs and incomes in New Zealand, the last thing we want to do is to be abetting by not passing such legislation the increase in borrowing costs for those New Zealand businesses. Of course, also, when we see news, especially also from the Council of Trade Unions around Christmas time, evidence of rising costs of living to New Zealanders, the last thing we want to be doing is exacerbating that by refusing to take action which would ultimately see the borrowing costs for those New Zealanders, whether it’s borrowing costs—most likely mortgages but potentially also other borrowings—increase. So it is important, we argue, that we agree to these reforms, and that we make sure that those derivatives are still accessible or derivatives contracts are still cost-effectively accessible to our banks.

Now, there was some talk about what the value of these might amount to. The information I have is a little different, but it could’ve been using a different source or a different representation. If we look at the gross flow of cross-currency basis swaps transacted by the four big banks against international counterparts, we see the total of that annually is as high as $8.7 trillion. But the risk element, the part that would be where the margins could or this could come into play, is about $90 billion for those four big banks. And by anyone’s reckoning, in this country at least, that is a great deal of money. I don’t think it would take too difficult a leap for New Zealanders to see a risk of that size as very readily potentially leading to interest rate impacts on them if the banks weren’t able to continue to access these moneys in foreign markets. So we certainly support Part 1, we think it’s an extremely good idea even if, obviously, the idea was somewhat imposed upon us through the actions of a global community. But as a community we wish to participate, and we need to, and we support it.

The licensing regime for administrators of financial benchmarks is also something in this first reading we are supporting. Although we always like to question, and actually this question is, unfortunately, so much easier to answer, but we always like to question the need for such regimes: to what level do they add in terms of process and compliance? Well, in this case, quite frankly, it’s as simple as if we wish to still access EU financial markets for these derivatives contracts we really have no choice but to accede to the changes that are being made in the EU, and to ensure that we have a proper licensing regime for administrators of financial benchmarks. The financial benchmark for New Zealanders, there may be a few listening, is a reference index or indicator used to determine the price value or performance of financial instruments like derivatives—for example, interest rate swaps and cross-currency basis swaps. The EU was somewhat concerned about potential benchmark manipulation, and those countries made a decision to prescribe new standards around the process for setting the benchmarks which administrators must meet if the benchmarks they set will be accepted by the EU. Those new regulations will take full effect on 1 January 2020.

So intervention—or the Government’s intervention, it’s their bill; but Parliament’s intervention—is necessary to avoid loss of access to those EU financial markets. A non-regulatory response is simply not possible because of the certainty and the measures that the EU requires, which is through a European Commission - equivalence decision based on our legislation. So we can’t simply say we’ll do something; we’ve actually got to evidence it through our law. On that basis, as we’ve said for Part 1, although the language of the bill and much language around the debate, and possibly the submissions, will be about financial markets and it will be about banks, ultimately, the result of all of that, the true end points are New Zealand consumers and New Zealand businesses and their ability to access borrowing for home, family, or, indeed, more importantly, some would argue, for the ability to support economic growth through the continued expansion of New Zealand businesses employing more people and, therefore, raising incomes.

So we do support this bill in the first reading. We look forward to the debate—I guess, in the Finance and Expenditure Committee—in select committee.

Can I, first, acknowledge the Minister Kris Faafoi for bringing this bill to the House—the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill. Can I thank the Minister for forwarding the bill on to the Finance and Expenditure Committee. All committee members are quite excited by this prospect and really keen to get our teeth into this bill in all of its detail. Can I acknowledge the previous speaker, Brett Hudson; that was a passionate and very focused speech. I think he’s really found his niche in terms of the legislative agenda today. So thank you, Mr Hudson.

The thing about this bill is that while it seems pretty technical, it is actually—as the previous member outlined—quite an important bill in terms of the functioning of our economy. It’s a bill that ensures that New Zealand firms can continue to be active in terms of securing credit and engaging in international financial markets. It’s a bill that ensures that we are complying with international standards in respect of those financial markets, particularly standards that have been set by organisations like the G20 and the EU. In a sense, really, it’s a case of New Zealand being a pretty small player, and these being the rules that big global players have set. The reality of the situation is that if we don’t ensure that we have a legislative environment that aligns with those rules, it will—as the previous two speakers outlined—make it very difficult for New Zealand firms to engage in those financial markets and access the credit that they require to function and that, ultimately, our economy requires to function as well.

I think the other thing that’s worth pointing out at the outset is that, really, these rules are in some respects the wash up of the financial scandals that were exposed at the time of the global financial crisis, and a little bit later in the London Inter-bank Offered Rate (LIBOR) scandal of 2012, which I will come to later on. So really what we see is a bit of a delayed regulatory process of international regulators looking back on those calamitous events in the world economy, and resetting the regulatory legislative environment to minimise the risks of those kinds of calamities happening again. Let’s remember that that global financial crisis stalled worldwide economic growth for several years and wiped hundreds of billions of dollars off global capital markets, caused huge unemployment, created instability in parts of the world, and to a large extent you can sheet home the trigger point for that global financial crisis to unregulated capital markets where the controls were too lax and where the big boys played hard and loose and engaged in greedy and unscrupulous behaviour because there was no one really looking. These rules are partly a response to that.

It does impact upon New Zealand in a significant way. It’s estimated that our major trading banks have over $1 trillion of exposure just in the EU to financial markets which will have to comply to these new rules. Major public entities like the ACC fund and the New Zealand Superannuation Fund also have significant exposure. Ultimately, if we don’t have a legislative environment that is compliant, the ability of those entities to engage in those markets will be cut off, and that would be a very serious problem. The Ministry of Business, Innovation and Employment, the Reserve Bank, and the Financial Markets Authority have been working on these issues for some time to ensure that we have rules that are fit for purpose, that minimise risk, and ensure our compliance to those markets.

There are two key areas in which the legislation enacts reform. The first I want to talk about is around the issue of benchmark rates. People might have a little bell ringing in their head when I talk about the LIBOR scandal of 2012. Now, the LIBOR is the London Inter-bank Offered Rate. It is, effectively, the average of the interest rates offered by the major trading banks in London, and it, effectively, became the default rate that interest was offered at. What emerged in 2012—through a scandal that erupted in Barclays Bank, but spread through many others—was that, effectively, unscrupulous traders had been fiddling with the rates, pumping them up or down at different times in order to create margins that they could make profit on. Sometimes they tried to pump up the creditworthiness of their particular institution. It was a massive abuse of the system that enriched a number of people within that system but created chaos throughout the rest of the system and disadvantaged ordinary people, ultimately. And so a series of reforms arising out of that LIBOR scandal centred in Europe ensure that there is far greater regulatory oversight of those who set what are called those benchmark rates.

Now in New Zealand, we have had a different system for determining benchmark rates, but what the new EU regulations say is that if you’re going to have your own local system for setting benchmark rates, then you have to have what’s called equivalence with the EU regulatory framework and so, ultimately, that is what this piece of legislation does. It ensures that we have equivalence so that we are able to ensure that we have benchmark rates that are considered to be valid and ensure that our entities can continue to engage in global financial markets. So that’s really, really important.

The second issue is around the issue of requiring margins and derivatives transactions. Now derivatives are financial instruments that sort of derive out of some kind of a real asset. So the financial instruments that are traded—they might be based on the value of certain commodities or they might be based on a real asset such as mortgage debt. These were commonly sort of sliced and diced and traded in that period leading up to the global financial crisis and what is being required under the new regulatory framework to mitigate some of the risks that arise out of derivatives trading, which is a huge financial industry—hundreds of trillions of dollars of money involved; so if something goes wrong there are huge effects across the economy. What the regulations from the G20 ensure—to avoid that sort of house of cards effect so that if one transaction goes wrong it flows on across all of the others—is that we have, effectively, some money on the table, what we call margin in those transactions. So if something goes wrong, there is actually some real money to fall back upon.

The issue we have is that within the New Zealand legislation certain bits of our legislation would not allow for that to happen, particularly our insolvency legislation, which for very good reasons has rules about who has first right of call on money if something goes wrong in certain situations. So this piece of legislation ensures that we can be compliant with the new regulations set by the G20 around margins so that our financial institutions can engage in the financial markets, particularly in respect of derivatives, and that ensures that they can access the credit and the capital that we need.

So those are the two key changes introduced by this bill: the changes around the regulation of margins and also around benchmark rates. These changes will ensure that we minimise some of the significant risks that are a reality in the modern financial markets and which caused so much damage in that period between about 2008 and 2012 as we reeled from the global financial crisis. And they will ensure that, going forward, New Zealand entities are able to engage with international financial markets, which we require to keep our economy moving forward. So it’s pleasing to see that these changes seem to be supported on both sides of the House. It’s a bit of a no-brainer really, and I certainly commend the bill to the House and look forward to considering it further on the Finance and Expenditure Committee. Thank you.

Well, I too rise to support the first reading of this bill, the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill. People who are tuning in to Parliament will be aware that quite often members on both side of the House support legislation and, in essence, it’s being covered—this bill is about ensuring that New Zealanders continue to have access to global capital through the EU by being up to speed with EU regulations and requirements around a particular element of the financial markets in the financial benchmarks. And so we need to get our law in shape by 1 January 2020 so as to enable continued access by New Zealand banks and major financial institutions to European funds.

I suppose the only point I’d make is that when we talk about access to global capital that is a highly topical issue at the moment. And this bill shows that the Government is prepared to do what needs to be done in order to maintain that access to global capital. But they seem to be totally blind at the same time to the effects of other Government policies which are actually reducing our access to global capital whether it’s our foreign investment rules or whether it’s the introduction of a major new tax on investment, the capital gains tax.

So we support this bill. This is logical, sensible stuff that needs to be done to ensure that we have access to global capital, but we do lament the fact that the Government is asleep at the wheel when it comes to the impact of the other pieces of legislation that they are considering.

Debate interrupted.

The House adjourned at 10 p.m.