Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill

on behalf of the Minister of Commerce and Consumer Affairs: I move, That the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill be now read a second time.

This bill reforms the regulation of our financial markets by bringing aspects of our law into line with international best practice. The key objective of the bill is to ensure that New Zealand’s financial institutions can continue to fully participate in international markets, particularly through the use of derivatives and financial benchmarks. This in turn will reduce risk in our financial system and costs for New Zealand consumers and businesses.

The bill has been reported back by the Finance and Expenditure Committee with a unanimous recommendation that it be passed with amendments. I’d like to thank the members of the committee for their careful consideration of this complex bill. The committee considered more than a dozen often highly technical submissions covering a range of matters. The majority of those submissions strongly supported the policy intent of the bill but the committee also recommended some important changes to ensure that the bill achieves its objectives.

To recap briefly what this bill is all about, Part 1 of the bill brings New Zealand into line with new rules around the trading of derivatives. Derivatives are used by a number of larger institutions such as banks when investing in raising money. While complex instruments, they are critical tools for managing risks. For example, banks use them to manage the risk that movements in the exchange rate will make it more expensive to repay money they have borrowed from offshore. Following the global financial crisis, the G20 brought in new rules relating to derivatives to reduce risks in international derivatives markets. These include requirements to post collateral which protects one party to a derivative from losses if the other party to the derivative defaults. These new rules have now flowed on to New Zealand and require us to change our laws to ensure our institutions can comply with the rules and continue to participate in international markets.

However, I think it is important to see this bill and what it does in its wider context. While on the surface it appears to be a highly technical piece of legislation about derivatives, the ultimate beneficiaries of the bill are, in fact, the New Zealand consumers and businesses that interact with, or borrow from, the banks. Without the changes in the bill, interest rates could increase potentially significantly and there could be negative impacts on the overall stability of our financial system. It is therefore critically important that we progress the changes in the bill to improve the resilience of our financial system and ensure our financial markets remain connected internationally.

Part 2 of the bill responds to a different but similar set of international reforms. The European Union recently introduced new regulations designed to improve the integrity of financial benchmark administration. Financial benchmarks are important tools used to determine the price or value of various financial instruments including derivatives. The EU regulations are part of a broader international effort to improve the stability of financial benchmarks and make them more resilient to manipulation. This comes in the wake of issues around manipulation of benchmarks by the likes of the UK banks in the London Inter-bank Offered Rate scandal.

The bill achieves these objectives by introducing a voluntary licensing regime for administrators of financial benchmarks in New Zealand, supervised and enforced by the Financial Markets Authority. This regime is both flexible and robust and will bring benchmark administration in New Zealand into line with best practice internationally, aligning with EU regulations. It will also be able to be adapted to future international developments.

Changes made by the select committee were: firstly, the Finance and Expenditure Committee has recommended some key changes to make sure the bill achieves its objectives and works from a practical perspective for industry. For example, the committee recommended that the transitional provisions of the bill be amended so that Part 1 applies to derivatives entered into before the bill comes into force as well as after. This change was necessary to address a practical issue related to how derivative users manage and exchange the collateral required by the G20 rules. The bill was also amended to require collateral to be in the possession or control of the enforcing party before they can enforce their rights to the collateral. This change will avoid confusion that may arise if there is an overlapping claim on the same collateral by other third-party creditors.

The committee also worked through the bill in detail to make a number of other technical changes that, while small in size, were significant in effect, particularly for a complex piece of legislation like this where the devil is in the detail. I commend the bill to the House.

Thank you, Madam Speaker. I’d like to congratulate the Minister the Hon Damien O’Connor on that speech. It does great justice to this bill—both as arid as the Sahara. The Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill is indeed an incredibly important piece of legislation in front of this House. It almost goes without saying that we as a nation of property owners and a nation of small businesses could not possibly hope to survive, let alone thrive, if our banks found themselves cut off or constrained in their ability to generate or get capital from around the world. So with changing requirements from trading partners and blocs such as the EU, it is important that we take the steps necessary to allow those banks and institutions to continue to access capital markets, but indeed enable New Zealand to continue trading with the likes of the European Union.

I actually sat on the Finance and Expenditure Committee for most of the business of this bill and it was—I would have to note that my colleague Andrew Bayly found the subject fascinating. And while we were all very studious and alert and participating, he truly understood to quite a degree all of the workings of the financial instruments that we were looking to regulate through this bill.

I would note one other point, Madam Speaker. Your most recent presiding officer colleague in her previous capacity also spent a small amount of time on the committee on this bill. We couldn’t help but chuckle across the table at each other when officials admitted that one item—which was an amendment to the bill, by the way—that was in the original bill, the outright transfers of collateral, or clause 18, wasn’t actually intended to be in the bill as it was originally conceived. What they had discovered was a small piece—well, small, but it actually proved to be quite challenging—of reform or tidying-up that they had wanted to do for some time found itself presented with a passing train that was this legislation. So they hooked that particular carriage to this bill, only to discover that it was a much more complicated task than they’d imagined. Ms Dyson and I looked across the table and had recollections of the last Parliament of officials doing exactly the same thing with a statutes amendment bill. Like this clause, that case was also quickly unhitched and sent down a siding so that we could continue with the substance of that bill then and this bill now. But it was a lighter moment in the passage of time in what proved to be an interesting yet dry subject.

We need this. These changes are important to ensure that Kiwis can continue to get their loans for things such as their houses that they need and that businesses can get loans to help them grow their businesses and to employ more people, because that is fundamentally what the economy is: it is the creation of jobs and incomes and prospects for New Zealanders. That is why we say our bottom line is you—it is New Zealanders. So we have no hesitation at all in commending this bill to the House.

As the new chair of the Finance and Expenditure Committee, I would like to commend the former chair of the Finance and Expenditure Committee, Mr Michael Wood, for the way that he shepherded this particular bill through the committee. It is a very, very technical bill. It is actually hard to understand the detail of the amendments and also the financial instruments that the bill deals with. They’re complicated, and it takes a bit of time and effort to get to grips with them. Mr Wood ensured that we got that time—that we did spend time with the officials—to really get to grips with the bill.

As the previous speaker, Brett Hudson, has done, I would also like to recognise Mr Andrew Bayly for his contributions to this bill. He was like a terrier going after each little wrinkle in the bill.

💬 Hon Member: A loud terrier.

A loud terrier but very effective. It was one of those bills where the committee did work together to get the bill right, so a genuine piece of cross-party legislation here, which is wonderful to see. I also commend the other members of the committee for the work we put in.

But I am going to take issue with one thing that the immediately previous speaker said, when he said that this bill was “as arid as the Sahara.” Does he have no imagination? This bill is actually critically important. Perhaps it is full of dry detail, but the intent of the bill is very important, and to call it dry is to, I guess, isolate New Zealand from the reality of the international financial markets that we need to deal in.

So I just want to perhaps explain a little of what the bill is about for people who are listening tonight before I move to some of the submissions on the bill. It deals with two particular issues that arose, really, in the wake of the 2008 global financial crisis. One is to do with the very complex financial instruments that were being traded and re-traded and re - re-traded and cycling around the world in a frenzy of activity in the years before the financial crisis. These were very complex instruments—instruments like futures and swaps.

Now, most people don’t understand what a swap is. The idea with a swap is that there are two parties: party A and party B. Party A perhaps has a fluctuating interest rate, and party A wants to stabilise that interest rate. So party A swaps their chain of interest payments with party B, who offers them a stable interest rate. That’s why it’s called a swap. Party B takes on the risk of the fluctuation. Party A might pay a little more in interest, but they stabilise the interest cost so they’re much more predictable. That’s a swap—the essence of a swap. Each party swaps their future chain of interest payments. They are hard to grasp, hard to describe in just words, and hard to value.

During the global financial crisis, instruments even more complicated than those were being dealt around the world into a real pile of transactions. They were, in theory, based on solid quality lending—the lending on mortgages—but even that was dubious, as an individual mortgage on a house, perhaps issued by a bank, was then sold on to another lender, and to another lender. Perhaps a mortgage, or at least the income flows from it, might be sliced up and spread across several lenders, packaged into deals, and then onsold, and then derivatives built on top of that. The transactions that were in progress were so complex that even those who were trading them—even the incredibly smart people, financiers, the people who specialise in finance and valuations—possibly didn’t even quite understand what was going on.

Following the global financial crisis, the world said we need to do better with regulating our financial markets. Part of the regulation that has been put in place is that each party to one of these deals has to be able to secure the flows of income from it—has to provide some collateral to make sure that if the deal falls over, not all is lost. Those are the types of rules that are now being brought in by the G20. If we as a nation wish to participate in those global financial markets, we too have to meet the standard set by the G20 in terms of financial institutions and how we deal in those markets. That is part of what this deal does. It sets the rules for how we do margins on derivatives, and it brings us in line with those major traders on the world scene. That’s part of what the bill does.

Another part of what it does is look at the benchmark rates that are used for valuing some transactions, in the wake of the LIBOR scandal. Now, LIBOR stands for the London Inter-bank Offered Rate, and, as it turns out, there was, well, shall we call it “very sharp practice”—so sharp that a lot of people got cut by it—that was going on around how that rate was set. Again, eventually rules have been put in place to determine how those rates are set, and this legislation brings us into alignment with those rules.

It was a very technical piece of legislation, and we did receive a number of submissions on it. I wish to read out the entirety of one submission. I won’t identify the person who wrote it, because the submission has two words. It says “Banking industry”, and that’s it. What it points to, though, is the concern that ordinary people feel with respect to what has gone on with banking worldwide and what has gone on with these financial markets—that ordinary people do feel that something beyond their control is happening and it destabilises their world. Of course, many people have many concerns with the banking industry. This person chose this particular bill to put in a submission on it, and it did have just those two words, but it does speak to a real concern that people have.

But the other submissions came from entities, from law firms like Buddle Findlay and Bell Gully and Chapman Tripp, who raised some concerns around how securities were discussed in the bill. They broadly supported the bill, but they wanted some changes to it. Another submission came from the New Zealand Bankers’ Association, again, dealing with some of the very, very technical aspects of the bill. The Restructuring, Insolvency, & Turnaround Association of New Zealand put in a submission, as did the New Zealand Financial Markets Association and the ISDA, the International Swaps and Derivatives Association. Some very highly accomplished and very highly educated people spent time and effort getting to grips with this bill and then coming and talking to the select committee about it to make sure that we understood as we best could exactly what was going on with the bill and how it needed to be changed in order to meet its policy objectives. So we thank those people for putting their time and effort into this bill.

Before I conclude the speech there is one other group of people that I wish to thank for their time and effort on this bill, and it is the expert officials who were advising us. They were—I hope they don’t take this as an insult because I mean it in the best possible way—wonks or nerds, people who really understood their material, really got to grips with it. I think they were quite pleased to spend some time discussing it with us, because often this sort of material is not widely discussed. As some of you may know, I used to work for IRD and when I said I worked for IRD, I knew about tax, it was an absolute—well, it certainly killed the social conversations. I suspect that the officials who worked on this bill, when they say they work on financial derivatives and financial markets, people go “OK.” and move straight on. It was a real pleasure to listen to their expertise and I thank them for their guidance as we worked our way through this bill. I commend this bill to the House.

Thank you. Well, you can be sure my contribution will be as agrarian as the last one was academic.

There’s an issue that I came on to the select committee very late in the piece with this bill. The other thing that intrigued me was I’ve followed Minister Damien O’Connor many times around this House but I’ve never followed him on a bill as technical as this. His understanding of it might be slightly better than mine but it is a very complex issue, this.

I think if you go back to my younger days in the finance industry and one or two of those things, I always thought this was some form of gambling. I guess the very fact that this has turned up as a bill and is of international concern really means it probably was a form of gambling, actually, just a very expensive one and a very complex one. I think that what we knew as hedging, once upon a time, I suppose has evolved into the use of derivatives and all sorts of other things. Of course, derivatives are really used to hedge a position, basically. The original design of them was, of course, to make a position much more secure. In fact, we saw many companies over the years make money out of hedging. Equally, many companies lost money in the same manner or by the use of derivatives.

So this bill is a bill that we support. It is a very technical bill. Most New Zealanders will never come across most of the terminology used in this bill and most of the facts. I thank Dr Deborah Russell for—this is the second time I’ve heard her give a great explanation of a very complex issue in this House. I’m very pleased that when she was spending her time lecturing at Massey University she taught those kids what to do and how to do it properly; hopefully they’ll know. Maybe some of those wonks she talked about were some she’d taught.

But it is a complex bill, and it’s a bill that we support. I think there will always be some doubt when you’re dealing with issues as technical as this as to whether you’ve got them exactly right. There’s no doubt, I think, that this will come back both internationally and locally in the future, because there will be some changes that will be required to just secure the position of this bill.

It does shore up, I suppose, our financial community—gives them the opportunity to compete in the world market on equal footing with everyone else, which is most important. It also gives them some protection in that market. So with those few words, I commend the bill to the House and look forward to the very complex committee stage in the House. Thank you.

I take pleasure in rising on behalf of New Zealand First to speak to the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill. Like Mr McKelvie, who’s just gone before, it does stretch my brain, a lot of this stuff. I’m not surprised actually, that Mr McKelvie doesn’t understand it. I expect he just pays cash for everything. He doesn’t need access to derivatives to make his purchases.

But it is, essentially, a very important part of our banking system, as we’ve heard. It brings our financial markets—it standardises them to the international standards in the new international standard that’s coming.

When I was looking at this, actually, I was reminded of—remember John Key was going to turn us into the Switzerland of the south when he sort of rode back here as the international banker from Merrill Lynch. I’m not quite sure that we ever quite attained that status. Although I do recall that we turned ourselves into a tax haven at one point and we had to do a bit of backtracking around some of those rules.

So it is important that we have a sound financial system. Derivatives are an important part of that, we’ve heard, for our banks but also for the likes of our fund managers, ACC and the New Zealand Superannuation Fund. So for all those retirement savings, our investment managers are using these instruments to leverage their investments. As we’ve heard, there’s a lot of risk, of course, that comes with some of these things. Deborah Russell suggested that maybe even the people that use some of those instruments don’t fully understand them. I don’t think that’s the case at all. I think a lot of those people understood them only too well and were leveraging them for all that they were worth.

Those of us that wouldn’t have understood them quite as well were vulnerable. We look at the LIBOR financial benchmark, the London Inter-bank Offered Rate—as I was wondering what the “o” was; I got the first four. But we know that that was manipulated in London, in the UK, and rigged. So this also protects us as ordinary individuals, with our money maybe in a KiwiSaver fund, from being exposed to those sorts of frauds. It puts us on a level playing field. I note the EU—we’re bringing ourselves into line with the EU, the G20; there are these regulations that are coming in on 1 January 2020. This will standardise us and bring us up to date with international best practice. We actually have to have them for our companies to be able to qualify to trade in those markets.

Of course derivatives are used, I guess, for leverage. The quantum of money you’re putting up is not necessarily the full rate, like Mr McKelvie might with his big wad of cash. So it does allow you to leverage up, but also there is a margin on that. The risk is taken by a margin, and if one of the parties default then that margin grows across and this is taken by the other parties. So that is covered within this bill—the amendments around margins and the rules around that standardising those rates a little bit.

So it does speak to the core of our financial system. With our banking we have got massive amounts of debt in this country. I think we’re over quarter of a trillion dollars, actually, of housing debt. We know we’ve got $63 billion of agricultural debt; add in Government debt, credit card debt, and we have close to half a trillion dollars’ worth of debt. So that financial system relies on these instruments that—whilst we might not fully understand them—are an integral part, and it’s important that we have the rules, and that regulations and legislation are absolutely fit for purpose to make sure that our financial institutions can operate efficiently.

One of the things that were raised within the select committee process was that if we didn’t have this it could raise interest rates, and, with that level of debt in this economy, any rise in interest rates is a material cost on this economy and this society.

So I’ll probably leave my second reading call at that. I think it’s been reasonably well traversed, particularly by Deborah Russell and others. But it is important that we have these standardised rules. This will allow that to happen. This is important. The committee the whole House may look to throw it round a little bit with the likes of Andrew Bayly and Deborah Russell, who do truly understand this stuff and can make sure that this is fit for purpose; as I’m sure the select committee, the Finance and Expenditure Committee, did a pretty robust job on this, because it is highly technical stuff. So I commend Michael Wood in his swan song on that committee for bringing this through, all the officials that have been mentioned before—we are really well served by officials and particularly in these types of bills where we’re really needing to be guided for the main part. So with that I will commend this bill to the House on behalf of New Zealand First. Thank you, Madam Deputy Speaker.

Can I first of all take the opportunity of congratulating the new chair of the Finance and Expenditure Committee, Dr Deborah Russell, and I want to particularly congratulate her for doing a nine minute and 30-second speech on this particular legislation. That’s not easy.

But I want to start by saying that this particular legislation is unique in the Government’s agenda, because finally we’re seeing some legislation that’s about making it easier for business to do business. So I congratulate the Government for doing that. There is just too much red tape and hindrance to business that’s occurring under this particular Government. So finally we’ve got them recognising international requirements that are difficult to comply with under our current old laws, and this legislation will certainly make it significantly better for banks and financial services to cooperate.

It’s about globalisation. This legislation actually recognises that we’re completely interconnected around the world. Whilst we currently have a batch of leaders around the world like Mr Trump and Mr Putin, and the UK with their ridiculous Brexit situation, trying to become more isolationist and more protectionist, the world is interconnected and we cannot undo globalisation, in my opinion. Nowhere is that more important than in the financial sector. Within this legislation, New Zealand is but a small player. So what you’ve seen over the last few years is that, led by the G20 and ably supported by the European Parliament, there have been discussions about making the financial sector more interconnected. That has led to a raft of legislation in the larger economies of the world, and, quite simply, as the legislation came before the select committee, we heard from the banks and we heard from the other financial services sector in New Zealand that current legislation in New Zealand does not comply with international legislation.

So the bill has two significant parts. The first part, Part 1, allows the banks and the big financial institutions of New Zealand—ACC, the New Zealand Superannuation Fund—to hedge risk. If you’re in that sector and understand that sector, it is absolutely critical that you have the opportunity to take a particular position on a risk if you want to. You can then get certainty from taking that position. It does come at a cost, but as significant investment managers, that may be an important aspect as they identify an investment strategy. That’s important to the likes of the super fund and ACC.

Then, Part 2 is all about the licensing regime. What this does is sets up a licensing regime that will be monitored by the Financial Markets Authority so that they can make sure banks particularly comply, and that’s been an issue of significant discussion recently, particularly around the current—let’s say—discussions between the Reserve Bank of New Zealand and the banking sector.

Can I say we received some good submissions. They were all, on the whole, very supportive for this legislation, and I just take this opportunity of commending the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill to the House. I congratulate the select committee and the work it did, and the sooner we get it passed the better for the financial sector of New Zealand.

Thank you, Madam Speaker. I had contemplated giving this speech in Te Reo. However, it’s that difficult to understand the technical language in te reo Pākehā, trying to find the language to explain it in Te Reo Māori, I think, would’ve stretched my Te Reo capabilities tonight. So I will be delivering this speech in te reo Pākehā, but it remains a challenge for me to actually be able to explain it in Te Reo Māori, because that would show that I truly have a good grasp of what in fact these things are that we call derivatives.

It’s a pleasure to take a short call on the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill in this second reading. I am a member of the Finance and Expenditure Committee, and there was kind of a little bit of joking that went on every time it came up on the agenda, but I was quite surprised when the Hon Ruth Dyson, who is not a permanent member of our committee, actually opted to come on to this committee and participate in this part of the select committee process.

💬 Kieran McAnulty: Hard-working member.

A hard-working member—somebody who is truly passionate about the issue. So I want to thank Ruth for her contributions. As we heard earlier in the speeches, there actually was an important point that was picked up by having her on the committee, and between the two members that was ironed out.

We received 13 submissions. You heard from the member Deborah Russell that one of them was very short—one of the submissions was very short. But we did receive 13 submissions, and most of those submissions were really technical in nature—many of them coming from the law firms who specialise in these areas of derivatives. We heard four oral submissions, and—a little bit unique to our committee, because this doesn’t always happen—we reported the bill back unanimously to the House. So it was a cross-party, collaborative effort to try and make this legislation the best that we could make it to perform the task that it needs to for New Zealand and for our economy.

This is an omnibus bill, so it will amend a number of Acts as a result of this bill going through. There are two primary objectives in the bill. One is to ensure that New Zealand’s financial market participants can continue to participate in international financial markets, particularly by using derivatives to hedge risk. The key point there is “can continue”, and I think that’s not necessarily well understood by everybody, because we are currently very used to the system and there are no issues. However, we were told that come September, if this has not passed, we would start to feel the impact of our law not being aligned with international changes and reforms that are happening, and then we would start to feel the impact of that—and everyday New Zealanders, not just the tax experts and the specialists and legal specialists in derivatives.

The second part is to bring New Zealand law in line with recent financial market reforms in the European Union and G20 States—which we are not part of, but we trade with them. Actually, I heard the figures being bandied around earlier, and they are figures that really stretch the brain and the mind. I’ve got a quote here that our exposure is estimated to total $1.1 trillion, either directly or through their clients, to derivatives contracts affected by the recent international reforms. That’s just our contracts with the European Union, and those are only our four large banks in New Zealand—$1.1 trillion.

I do just want to briefly, and on a light note, mention that the Hon Judith Collins made a comment that this was so dry, so boring, and so not sexy that it was unlikely to get any media coverage, and that if it did, she would bake for us. Well, guess what? We can thank the New Zealand Herald, Nikki Mandow, for in fact writing a really good piece on this legislation. As a result of that, Judith made the most outstanding Louise cake for our select committee, and I thank her. Tēnā koe.

It might sound dry and technical, and it is, but it is a very important part of the financial markets of the globe. It is time that the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill actually got through this House. We do need to make sure this omnibus bill passes, because otherwise the New Zealand financial markets will be unable to participate in international financial markets—particularly those that use derivatives.

Now, Deborah Russell, who’s the new chair of the Financial and Expenditure Committee, spoke of all the things: derivatives, swaps, swaptions, hedging—there’s all names for it, but, basically, they’re about somebody taking a risk on the value of something and hedging it against something else. If we don’t have rules around this, there are two things that can happen. The first is the people that take these out don’t understand the full consequences of what could happen if it doesn’t quite work out. In the global financial crisis, people lost their shirts—many of them.

Secondly, the other thing that also happens is there are always two sides of an equation. There is a winner and there is a loser. So if you make money in one of these financial instruments, generally it will mean that somebody on the other side is losing money. So you absolutely have to have your wits about you—particularly if you are not offsetting.

Now, most people in New Zealand will understand hedging—more commonly used in markets around electricity and fuel. So the likes of Air New Zealand would hedge against the price of fuel. That gives them some certainty today of the price of fuel into the future. If the price of fuel goes up, they will correspondingly make the same amount of money on the other side. So the net result is the price of fuel will remain static—very similar. But it is a risky business. I think Mr McKelvie said previously that it’s a gamble, and it is.

In my former life, when I was farming, I was persuaded to go into a swap by a banking entity.

💬 Dr Duncan Webb: Oh no! The ANZ?

It was actually the ANZ at the time. To be honest, I didn’t know a lot about it, but we were persuaded. We took advice and we did it. We secured that against the mortgage and we borrowed internationally. It worked out very well. The net result, at the end of it, was that I think we netted something like $50,000 over that period for doing nothing. That same year we lost about $50,000 worth of land in a big storm. So it was sort of meant to be.

But as I stand here in the House, there are hundreds of people signed up to these type of arrangements, and all care was given for us to understand, but I pretty much guarantee that most people at that level in the market have very little understanding of the risks they particularly face or the debt they can get into.

So we support this bill. We think this brings us in line with the G20 countries, what’s happening in the European Union, and it makes common sense. Sometimes we have to go through difficult circumstances or see something that doesn’t work for parliaments to respond, and I think it is our duty and obligation to pass this bill as soon as we can. I commend it to the House.

So this is a split call. I call the Hon James Shaw.

Thank you, Madam Speaker. It’s a pleasure to rise in support of the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill on this, the second reading. I also just wanted to join some of my colleagues in commending the work of the Finance and Expenditure Committee in working their way through what has previously been described as an extremely dry and, some would say, boring piece of legislation. But it’s very technical nature, I think, requires a higher standard of us as parliamentarians to be able to engage with it. When it gets to this level of kind of nitty-gritty detail to do with derivatives and similar financial instruments—which is not something that most people are familiar with—it actually does call for a pretty high level of engagement. I also just want to thank the officials who were engaged in this for supporting the committee through the House as well.

I just wanted to pick up on some of the comments of some of the previous speakers in this—I won’t go quite so far as to call it a debate, because it does appear that the House is completely united on this issue, and that is a good thing when we’re dealing with financial services regulation. But the previous speaker, Lawrence Yule, referred to some of the issues around the global financial crisis (GFC) of the late 2000s. It was a pretty colossal event. It wiped about 2 percent off global gross domestic product. Hundreds of thousands of people were out of work. It affected New Zealand’s economy for a decade, and gave us a pretty tight operating environment to work within. We had, here in New Zealand, probably one of the better-insulated economies from the GFC. The reason as to its cause was because of poorly regulated financial services and financial products. This bill directly derives from that in some ways, in terms of some of the regulation.

The issue is that when it comes to financial services, regulation always follows innovation. That is where you run into trouble, because, of course, the incentives for banks and other large financial institutions is to constantly innovate in order to drive up their own profit margins. It’s very difficult for regulators in an, essentially, globalised finance market to be able to respond appropriately with regulation that matches the innovation that’s coming through. So the provisions in this particular bill are, essentially, following G20 and European Union regulations that are attempting to catch up with some of the innovations that are occurring in the derivatives market.

I think it’s really important for the House to engage with that, because what we need to understand is that once we have gotten through this bill, it’s probably about time to start looking at the next tranche, because things will have moved on, such is the speed and the pace of innovation in financial services. That really speaks to the other purpose of this bill, which is that this kind of regulation ends up being, effectively, global in nature, because we are dealing with global capital markets. Therefore, the regulatory environment that we have here in New Zealand has to match the regulatory environment of other countries as well.

So I think—for all the people who’ve said that it is kind of dry and turgid and so on—that it is actually really important for us as parliamentarians to engage with this, and to make sure that the quality of the regulation is high, and that we really understand what it is that we’re doing when we pass this bill. To that, I just wanted to say that I think the changes that the select committee has come back with are very sound. They’re not huge. There are about four of them, but they all—to my reading; not having been involved with the select committee directly myself, but having looked at the papers that have come out of it—seem to make a great deal of sense. So I would say that we have to support those through as well.

As I said at the start, I commend the work of the select committee, of the officials, and I commend this bill to the House.

Oh look, thank you, Madam Speaker. I too rise in support of this Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill in its second reading. I actually want to take the time to thank colleagues from both sides of the House for explaining this bill in plain, simple English, despite it being quite technical in nature. But I would have to add to that that any bill that looks to improve efficiencies, to create a more sound regime, and to cut red tape needs to have attention, and needs to be passed forthwith so that our lending institutions can obtain capital in derivatives, so that they too can on-lend to New Zealanders.

It’s this side of the House that supports an expansive economy, despite the Government’s best efforts to slow it down through its various reforms. But we are the supporters of business, businesspeople who take risks, businesspeople who look at their trading or their provision of goods and services. If there is a chance for expansion, and the need for them to obtain capital to do that, then we want to make things easier for them to obtain that capital, and to expand their business, because, ultimately, that means that they will take on extra people. There will be extra employment opportunities available, and that of course puts food on the table for that person, so that they can achieve their hopes and dreams. So any legislation that reforms our banking sector, that means that our banks can obtain capital in line with international regulations, is a good thing, and we certainly support that.

I just want to end with congratulating Deborah Russell on her appointment to the chair of the Finance and Expenditure Committee. We had the privilege of having her chair the Environment Committee. She was extremely apt. She is a very fair and collegial chair, and I’m sure she will bring the same aptitude to the Finance and Expenditure Committee, and I do wish her all the very best as she takes on that role. So with that, with a very short call, I support this bill.

It’s a delight to be able to make a contribution to this discussion this evening on the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill. Now, I’m not sure if this was a common practice across the House, but what I did to get myself familiar with derivatives and their origins—I did what all millennials do, and I turned to Netflix, and, in particular, the movie The Big Short.

💬 Dr Duncan Webb: Oh, it’s awesome.

It’s a fantastic movie, but, I mean, basically, if anything can be said about the global financial crisis (GFC) and its origins, it does come back to the way that trading began to be operated on this faux—well, it’s not faux. Now, it’s an important monetary asset and policy—but, around the origins of derivatives and their role that they play in a modern economy. Now, in 2008, we saw what happened when you had, effectively, an unregulated market where the most common example of a derivative then was a mortgage-backed security. The lack of regulation around these derivatives, and these types of loans, we saw had the impact of mortgages falling 31 or so percent. I think it drove us into the worst financial time of our generation—well, in my particular lifetime, but since the Great Depression.

So in response to the GFC in 2008, many people knocked heads to work out how they could bring more security to this particular area of finance. It’s been brought to the attention of this House, from a number of contributors this evening, the role that the G20 have played, and the determinations that they have made. Now, we aren’t one of those G20 nations, but we are, indeed, very much interrelated, and our trade is very much interrelated, and our economic positioning in the globe is very much interrelated on those trading relationships with those nations in the G20.

As well, Madam Speaker, you’ll be very familiar—this House is very familiar with the determinations that the EU have made to bring regulation to the way that their derivatives and their markets operate. Now, those rules, they come to a head, or they will be enforced in the EU from the start of next year. So this piece of legislation, under the stewardship of Minister Faafoi, introduced into this House in February, went through a relatively robust and technical process in terms of ensuring that this piece of legislation was fit for purpose for our domestic response. Whilst we weren’t inundated with submissions, we were, as one of my colleagues rightfully said prior, privy to some very technical, well-thought-through, and, indeed, very useful submissions—13 in total, and I must commend the levels of expertise from those that presented before the Finance and Expenditure Committee.

Now, the bill that is before us this evening for this reading does come to this House with a number of amendments, and they are amendments that we have heard, and I sincerely hope that the submitters feel we have adequately responded to those submissions that we heard. In particular, there was some consternation amongst the submitters around the transition times in the provisions of the bill, and, in particular, at what point—when you break the bill up—Part 1 would come into effect and how that would come into effect.

So one of the amendments that we have made is to ensure that Part 1 applies to derivatives entered into before the bill comes into force, as well as after. Now, this amendment was, essentially, necessary just to address the practical issues that related to derivatives users, and how they managed and exchanged the collateral required by those G20 rules. Another amendment that has been brought through into this bill—we’ve proposed the amendment to require collateral to be in the possession or the control of the enforcing party before they can actually enforce their rights to the collateral or obtain those special protections, I guess you could say. This change, essentially, will avoid confusion that may arise if there are overlapping claims to that same collateral, or by other third party creditors.

Another amendment that we proposed, in response to some of the submissions that we received, is, essentially, a whole range of relatively small but technical amendments that, when read in the totality, I think, will probably give our submitters—and, indeed, the financial sector that rely on trading upon these derivatives—the security that they require.

In addition, this bill also establishes a licensing regime for the administrators of other financial benchmarks under the Financial Markets Conduct Act. Now, this has been introduced, of course, in response to the new regulations that have been developed by the EU, and I spoke about how those are coming into force relatively soon. Now, these regulations do have an effect outside of the EU and upon us, effectively, as a foreign jurisdiction that wants to trade. So the benchmark administrators in those jurisdictions must meet a whole range of particular requirements in their new regulations in order for the benchmarks that they administer to be used as an important financial instrument with the parties that are located in the EU.

We heard from a range of large banks and large private and public sector organisations, all of which rely on entering into various derivative instruments with EU counterparties and, of course, G20 counterparties. I think it’s been widely canvassed in this House just how significant those derivatives are for hedging investments, capital-raising purposes, and the like.

So, I mean, there have been a few laughs this evening about the fact that this is a relatively dry piece of legislation or it lacks in flair. I refer to the comments of my colleague Willow-Jean Prime from Northland. She mentioned that the Hon Judith Collins made the papers for her comments around how lacking in interest this type of legislation is. But it isn’t. This is sexy legislation—there you go, I’ll go on Hansard and say that—you know, for the wellbeing of our ability to trade with our larger counterparties, the EU and the likes. We saw the harm that can occur when the derivative market remains unregulated. Whilst it’s a little late in the piece—probably about 11 or so years on—New Zealand’s doing our part to make sure that the derivative market we rely on does have safe benchmarks in place. I commend this bill to the House.

Oh, Madam Speaker, thanks very much for that. I’m not sure I can add a huge amount after that comprehensive speech by Kiritapu Allan, but I was sitting here listening to Mr Yule mash through his exchanges with the ANZ bank, and I thought to myself, well, how can we understand derivatives and explain them in a way that even a boy from Havelock North can understand? So I thought to myself, well, let’s put it into a currency that the boys from Havelock North will understand and imagine we’re buying ourselves a Holden Commodore, because Mr Yule may well want a Holden Commodore and he may not be able to pay for it now; perhaps he’s going to buy it next year. He might rightly be concerned that the price of his Holden Commodore will go up, and so he might want to deal with that risk in some way and come to me, a derivatives broker, and say, “Duncan, I’m concerned about this.” I would say to him, “Mr Yule, if you pay me a hundred dollars, I will guarantee you the same price next year.” There we have it. I have derived value from that transaction—a transaction which is yet to occur. I’ve got my hundred dollars; Mr Yule has certainty that he can get his Holden Commodore next year.

Of course, he may be getting that Holden Commodore from Australia, and he may say “But Duncan, I’m also concerned that my New Zealand dollars won’t be worth tomorrow or next year what they are today.”, and I’ll happily take another hundred dollars off Mr Yule and say “Mr Yule, I will guarantee you the exchange rate as well.”, and there we have a derivative related to foreign exchange. Of course, he may in fact be borrowing the money and say, “Well, Duncan, I’m actually going to have to borrow the money, but I can only afford 10 percent interest and the bank will only give me a floating rate.” So, once again, I will take a hundred dollars off Mr Yule and guarantee him an interest rate—another derivative.

Or perhaps Mr Yule simply wants to be absolutely sure that there will be a Holden Commodore to buy in a year’s time, and I will take another hundred dollars off Mr Yule and guarantee him that there will be a Holden Commodore—we have a futures contract. There we have, in pretty much a nutshell, how to explain derivatives to someone from Havelock North and how for me to make 500 bucks very quickly from Mr Yule. So—

💬 Jan Tinetti: Who lives in Napier.

Oh, well, it’s pretty close—it’s pretty close.

In any event, that’s what derivatives really are; they’re laying off risk, and they’re called derivatives because they derive their value not from assets in themselves but from transactions related to those assets, whether those assets be gold or shares or currency or some other asset like a Holden Commodore or pig bellies or whatever you like. But the thing about these transactions is because they are derived—because they actually depend in their value on movements and markets—they’re extremely volatile, and so large sums of money can be lost or made very, very quickly. That is why it’s only the very largest institutions that enter into these transactions, because only they have the financial assets to do so.

What it also means is that when there is a default, that default can be catastrophic and also cascading, because one of the problems with these transactions is they build on each other. We can have derivatives on derivatives on derivatives, and as Kiritapu Allan rightly observed, in the movie The Big Short in the global financial crisis, one of the problems was this domino effect of one financial institution having to meet its derivatives demands, which then led to another financial institution and so on and so on and so on. That’s why this bill is so important, because it strengthens the derivatives markets. One of the key things it does is it makes sure that a person who is on the receiving end of the derivative—the person who is, essentially, the guarantor—can access collateral for guarantee, because these transactions are so huge that guarantees of millions and billions of dollars are put up on the international markets, often in cash reserves or other highly liquid assets. In our domestic framework, we have an entirely different securities regime where if a company goes into liquidation, there is a careful, ordered, and extremely slow process for unwinding these transactions. On the international financial market, that’s not good enough, because if you have to wait six months for $5 billion, that will simply lead to a catastrophic financial collapse.

So one of the key things that this bill does is it makes sure that parties can access collateral pretty much instantly—that is, within a matter of a day or two. So even if a large company, one of our trading banks—God forbid—is put into statutory management, under statutory management, under our law, every asset of the company is frozen. This is an extraordinary exception to that, which says no, except for the margins they’ve put up for their derivatives transactions. In that case, the international parties will be able to access that, because that’s how derivatives work. I must say, when I saw that, when those excellent policy wonks came in and explained that to us, I raised an eyebrow. I must say, when you’re in the world of derivatives, raising an eyebrow is tantamount to thumping the table. It’s a pretty crazy world. It seemed odd to me that all of the mum and dad creditors out there would have to wait under statutory management for their money but, you know, JP Morgan or whomever out there could immediately access their margin.

Now, I must say, the officials were very good and did very carefully take us through exactly how that would work and how, in fact, it was only a small amount of the assets that would be available, and also that the international financial system was very dependent on this kind of access being available. It wasn’t only statutory management, but also the Companies Act itself, essentially, is set aside for—it gives super-priority to these derivatives margins, and also the Personal Property Securities Act. In many ways, these transactions are personal property securities, because personal property, asset, is given at the disposal of another person if you default on your interests, but it’s entirely inappropriate for that domestic piece of legislation, which is really aimed at things like car transactions and financing farm machinery, to be part of the international derivatives framework. So that was really important to get those rules right.

It’s really important, though, to remember that this isn’t just for any Joe or Josephine Bloggs down the street. This is only for banks, the Superannuation Fund, and ACC, and if anyone else is in that league they can apply to come within this framework. Also, my colleague mentioned financial benchmarking licencing—that’s really important too, because many of these derivatives will be triggered when certain events happen. A classic one would be when the exchange rate falls below a certain level, or where the interbank interest rate rises to a certain level.

Now, we know from the London Inter-bank Offered Rate scandal that if you leave the market to itself, there will be manipulation. In that situation, the threshold was the rate at which banks would offer money to each other—a weighted average of them. Now, there was a cartel of banks which manipulated that so that they could make money on derivatives over there—manipulating interest rates here on a particular time of the day so that they would trigger derivatives events over there. That’s fraud. That’s utterly unacceptable. And it’s because they weren’t carefully regulated. So what we have here is buying into a regime of financial benchmark licensing to make sure the systems used to reach those benchmarks are defensible and transparent. What that means is that our systems will be recognised internationally, we will be able to trade internationally, and we will meet those European standards that we’ve heard about already.

There’s one other thing I want to note which is quite interesting, and that’s the commencement date. It might seem very boring, but it turns out that if we had a black-and-white commencement date here and we said this applies to everything in the future, we would run into huge problems, the difficulty being that many of these derivatives transactions are kind of portfolio transactions, so it’s a shifting pool of assets which doesn’t have a clear beginning and a clear end. To unwind them and say the commencement date applies to this transaction but not that one would be a hopeless mess. So it was decided that, in fact, it would apply retrospectively in those situations.

So, an excellent, fascinating piece of legislation. Thank you to the officials: an excellent job. I commend this bill to the House.

I’m very surprised to be able have the opportunity to speak on this bill in the House this evening—surprised that the Opposition hasn’t taken the opportunity to elucidate on the benefits of this bill, which they do support. Members across the House on the select committee actually work quite hard—on the Finance and Expenditure Committee. While it’s been pointed out that this is a relatively uncontroversial bill, that doesn’t mean that it was a bill that members of the House have not had to engage in. Members of that committee actually spent quite some time taking a range of submissions, many of which were very technical in nature, from the financial services sector and other interested parties, and engaging with officials on the detail of this bill to ensure that it was fit for purpose.

But, none the less, like a hungry hound with the scent of some very tasty meat in its nostrils, here I am with the opportunity to say a few words on this bill. I want to commend my colleague Duncan Webb for his speech just now. It was a bit derivative though, I thought, of some of the other speeches—but it was by some margin better than others as well.

This is a very important bill, and it actually speaks to some of the Government’s core priorities. This is the Government that believes in a strong economy. This is the Government which believes in getting on with the job of ensuring that we have a stable financial and economic system so that Kiwi businesses can prosper. And while I know that at first blush, when people look at pieces of legislation like this, they can go a little bit cross-eyed, the ability of our financial institutions and others within our system to access debt on world financial markets, ultimately, is important for our economy to continue as we would wish it to and for businesses further downstream, ultimately, to get access to the credit that they need to be able to function.

This bill does two important things, which are actually quite discreet. They’re tucked into the same bill, but they come from different international requirements. And it’s worth pointing out at this point that the bill is absolutely crucial. These, effectively, are requirements, if we want our financial institutions to continue to be able to access debt on international markets.

The first requirements really come out of the G20, and this is around the requirement to provide margin or real collateral in the event—well, to cover for the possibility of default securing when the derivatives are traded. This really goes back to that very difficult period in the international economy in 2007-2008 when our international financial system virtually collapsed. It virtually collapsed, and the consequences of that were dire. Now, many of us felt, quite frankly, a lack of sympathy for many of those institutions, because of the way that they behaved and the absolute greed and recklessness with which they conducted themselves at that point.

But the point of the matter is that however one might feel about the impact on those institutions at the time, the downstream effects on the real economy were absolutely horrific. The entire world entered into a period of significant recession—as significant as the recession that we saw after the 1929 stock market crash. And that meant real impact on the lives of people around the world and here in New Zealand. We saw unemployment—which, I’m happy to say, under the previous Labour Government had reached a record low of just 3.4 percent—roughly double as a result of that global financial crisis (GFC). We saw businesses fold. I remember at that time, in the aftermath of the global financial crisis, driving around my community in Auckland and there were just empty shops, empty factories, empty businesses everywhere. That wasn’t the fault of the people in those businesses, but it was a direct consequence of what happened in that global financial crisis, where some of the wide boys in these big institutions were playing fast and loose, were lining their own pockets, were behaving recklessly, but it had an effect on the real people.

That is why these changes are important: because they are, fundamentally, about the response that certain international institutions have had to ensure that we build a more robust international financial system. That doesn’t eliminate the risk of that occurring again—because, quite frankly, that is impossible—but does at least significantly mitigate against the risk of that happening again.

So those first sets of requirements have come through from the G20. New Zealand is, obviously, not part of the G20; our close neighbours Australia are. But that’s been a very important forum for developed economies to come together to look at how we strengthen the global financial system to mitigate against these risks as much as we can. In essence, what we see in Part 1 is the requirement that people who are engaged in derivatives trading do provide that margin, that kind of real collateral, putting some real skin or some real asset in the game so that in the event that a derivatives trade goes wrong, there’s actually something real to fall back on. What we had in the in the period of the GFC was a contagion effect, where a whole lot of things went wrong in that global financial system in one or two major institutions, and because they were also linked up because of these trades in the derivatives market, it spread like a disease would spread through the body. But in this case it spread through the global financial system and rippled through. We had major trading banks all around the world, starting in the US and in the United Kingdom, going under. And that’s where the damage was done.

Now, the challenge in this case is that some of our domestic laws already put obligations on parties who might be engaging in these trades in terms of where any collateral might need to go. And actually, what we need to do in terms of the regulations the G20 has put in place is make sure that that collateral is available to the parties in the event that something goes wrong. As my good colleague Dr Duncan Webb pointed out, one of the important features of this is that there’s quick access to it. That, again, is about dealing with that contagion factor. If you go for days and days and days and these contracts are, effectively, unwinding, you get mass panic, mass loss of confidence, and that’s when things really spread and get very, very ugly indeed in the international financial system. So that’s why that first change, which is captured in Part 1 and comes out of G20 regulations, is so very important.

The changes in Part 2 come from our good friends in the European Union. This is part of being part of a globally connected economy. The EU is one of those places that we do often look to for being a place of public-good regulation. The EU has often been a bulwark, in my view, against the excesses of corporations in the global economic system who simply want things their own way, who don’t particularly think about the public good. They simply think about maximising private profit. It’s often EU regulations—and we can think, for example, about some of the significant work they’ve done in the space of social media regulation recently; and New Zealand’s played its part there with the Christchurch Call as well. But in this area it’s the EU who’s actually looking really closely at regulating these international financial markets to mitigate against the risk. And let’s not forget that, if that risk becomes real and if those big losses occur in the international financial sector, there’s an impact on the real economy.

But who carries the can? Who carries the can? It’s not actually the big boys in the glass towers, in the international financial institutions; they’ll generally find some nice little bolthole to go into. It’s generally the public purse, and across the globe at the time of the global financial crisis it was Governments who had to bail out these companies and often had to buy up the banks. Here in New Zealand, we had our own version of that when we had to buy up a number of the second-tier lenders who had been greedy and reckless in that period—South Canterbury Finance is a prime example. So we need these strong regulations in place so that we don’t have the situation of extreme private profiteering, effectively underwritten by the public purse and, ultimately, the taxpayers.

In respect of Part 2, what we’re talking about here in particular is the manipulation of financial benchmarks, and these are the benchmarks—these are the indices—which have a very significant effect in terms of setting interest rates. We had the LIBOR scandal in the United Kingdom some years ago, where it was found that financial institutions—and, while they were called “rogue traders”, I think it was actually more systematic than that—were manipulating those rates to maximise the profits that their institutions could make by making quick trades on the basis of small differences in those margins. A similar scandal emerged in Australia some years ago as well. So the regulations which come out of the EU, basically, put in place much stricter regulation of those interbank rates, and that’s incredibly important.

It’s an important piece of legislation. I’m pleased that, surprisingly, I’ve had the opportunity to speak on this. I again say that I’m surprised that the Opposition, who generally consider themselves to be very financially literate and across these kinds of things, haven’t taken the opportunity. This is the Government that’s getting on with the business, building a strong economy, and putting in place the legislation that our economy needs to thrive. I’m so very pleased to finish this debate by commending it to the House. Thank you, Madam Speaker.

Bill read a second time.