Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill

Thank you, Mr Speaker. It’s a pleasure to be talking on the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill at its third reading. Of course, we’ve had a few speeches on this bill, which is quite a technical bill dealing with an issue that not a lot of people have the opportunity to be involved in, but it’s about allowing entities, and particularly banks and financial institutions, to be able to use what’s called derivatives or hedging instruments to be able to manage their risks when they want to go and borrow money—as an example—or just generally to operate.

A good example is those foreign currency swaps where you might want to ensure that you always maintain a New Zealand dollar amount on your balance sheet but you have to borrow in US dollars. So you can swap that out at the time that you borrow that money, and when you have to repay it have a fixed rate at which you would repay it. That’s normally covered during that intervening time through an interest rate cost that’s a part of the cost of the derivative.

Another example is on interest rates. Often people borrow money at floating rates from offshore, and they may want to make sure that it’s fixed at a known rate and they can enter into interest rate swaps to ensure that, again, they have the ability to control that risk and manage it in a way that they want. Of course, other parties may want to take on more risk, because risk often correlates to a higher return, but not always, of course, as Madam Speaker will know.

Just to put this in context, this is a huge, huge trading platform that financial institutions use; not only banks but our large financial institutions such as the New Zealand Superannuation Fund, a $40 billion fund, the ACC fund—$40 billion as well. They all use it and most large corporates use it to some extent. Just to give context, the current value just of New Zealand trading banks annually is about $8.7 trillion, estimated. Of that, about $90 billion every year is with international counterparts.

This is the essence of this bill, because what this bill is doing is actually reacting to the European and the G20 requirements, as a result of the financial crisis, to make sure that these types of instruments have sufficient security—or another term for that is collateral—to ensure that banks do not get overexposed or financial institutions don’t get overexposed. The European Union and also the G20 have set about, around the world, putting in place some rules that have been agreed to make sure that there is a platform or an understanding about the collateral arrangements that go with it. New Zealand at the moment is slightly out of step with that.

What this bill seeks to do is bring New Zealand in line with those international requirements. It requires a lot of changes. It requires changes to the Reserve Bank of New Zealand Act, it requires changes to the Insolvency Practitioners Regulation Act, and it also requires changes to the Financial Markets Conduct Act.

I think that the main point about this is that we had a number of very technical submissions on it, but the first thing was around collateral, as I mentioned before. The issue is this: when you enter into a trading agreement or a swap of some sort, if an event occurs that will mean that the swap is not going to be paid or one of the parties, it may be the counterparty, fails for some reason, what is the collateral that sits in the middle that provides security to the person that has provided that loan? That point of collateral recognition, at the moment, is very confused under New Zealand law because it really doesn’t anticipate it, particularly under the Personal Property Securities Act. All these rules in New Zealand actually frustrate the ability of someone who’s legitimately entered into a swap to be able to grab the collateral, normally in the form of a margin and to apply that against the losses they may receive with the counterparty not actually fulfilling its obligations. That’s an important part of this bill.

If you’ll allow me to pick up where the previous speaker, Andrew Bayly, left off about some of the important aspects of the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill. I just wanted to acknowledge the previous speaker, who gave, I think, a fairly detailed rundown of what’s in the content of the bill. I just wanted to sort of lift it up—this being the third reading of this bill’s passage through the House. So, of course, it will shortly become law.

💬 Andrew Bayly: Second reading

As the—sorry. I beg your pardon, the second reading.

💬 Hon Members: Third.

The key point that the previous—it is the third reading? All right, I beg your pardon. You got it wrong, Andrew.

💬 DEPUTY SPEAKER: It is the third reading. We are on the third reading.

He had it wrong. Yes, yes.

💬 DEPUTY SPEAKER: I’m saying that.

I was getting confused. Yes, I should always follow your guidance rather than an Opposition MP, Madam Speaker. The point that the previous speaker was making was that the whole point of the bill is to enable organisations that are engaged in these cross-border transactions to have an ability to manage their risk, including, as he said, the ability to actually take further risks if they want to, but in an environment that enables that. Current regulation, as it stands, doesn’t quite get there.

So I think there are a couple of key points that I’d like to make about this particular piece of legislation which I think help to enable that environment. The first is—and again, Mr Bayly referred to this—that what we’re doing with this piece of legislation is really aligning the New Zealand regulatory environment to that primarily of the European and Australian environments, with whom we’ve got quite close contacts, and a generally accepted global regulatory environment. I do want to acknowledge the officials that have worked on this, because this is a very complicated and technical area of regulation. To ensure that we are able to update our own regulation in a way that actually matches what’s going on in the rest of the world and to attempt to keep pace with that is no easy task.

I think, actually, one of the things that’s going to have to happen, of course, is that as soon as this piece of work is complete, we’re going to have to be looking at what’s coming next—what’s coming down the pipeline—because, certainly when it comes to financial services, regulation always follows innovation. If you don’t keep abreast of the innovation, and you allow your regulation to stagnate at a point in time whilst things move on, then you actually end up creating more instability in the market place. It can lead to the use of unregulated financial instruments, which can lead to some pretty negative consequences, the most famous, of course, being the global financial crisis that we all lived through in the not too distant past. So I say that both to commend the officials and to just to kind of put on the record that we cannot stop here. We actually need to keep up the work and make sure that we’re not falling behind and that we’re staying current, not just of the rest of the international regulatory environment but of what’s going on in industry as well.

The third point that I’d like to make about this, having spoken on this bill a number of times, is that this is one of those pieces of legislation that does have unanimity across the House, and that is significant when it comes to this form of regulation because what it means is that the markets are able to look at this and say that the will of Parliament is completely clear. There is no one who is questioning that this is the direction of travel that we have to go in. That means a much more secure operating environment for those businesses that are participating in the market. I think those things combined—the fact that we’re bringing our legislation up to date with the international environment and the fact that we’ve got unanimity in the House on this particular piece of legislation—do actually create that environment for businesses to be able to say that they are able to manage their risk in a supportive environment. But I say that, again, with the caveat that this is, essentially, past-looking, and it’s saying, well, we are literally just catching up with where industry and other markets have gotten to. The risk always that we, as a House, need to manage, and that the Ministry for Economic Development and Inland Revenue and so on and Treasury need to constantly monitor, is what is going on in the market place that we need to stay abreast of.

So I am pleased that we’ve managed to get to this point with this legislation. As Mr Bayly was just saying, it is a very technical bill and not an easy one for people to follow, but it is important, because a good regulatory environment, in this case, enables a more secure financial environment and a more stable financial system for us all to operate within. That, particularly given the current headwinds in the global economy, I think is important for us to maintain. So with those thoughts I’d like to say, again, to the officials: thank you for your work. Thank you to the Finance and Expenditure Committee who have pored over this for many hours, and to the submitters. I think that what we’ve got here is a good piece of legislation; I commend it to the House. Thank you, Madam Speaker.

Thank you, Madam Speaker. It’s a great pleasure to take a call this afternoon on the third reading of the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill. I’m, unfortunately, not a typical member of the Finance and Expenditure Committee but I was fortunate to sit in on some of the considerations, deliberations, of this bill. It was very well chaired by Mr Michael Wood at the time, but I’d also like to acknowledge the contribution that Mr Andrew Bayly has made, the member for Hunua, because—as has been pointed out, I think, by a number of speakers now—he’s probably uniquely qualified to speak on this bill as he has very, very in-depth knowledge of the subject, and showed exactly why this afternoon.

As has been said quite a lot, actually, this bill is needed primarily for keeping access to capital by banks. It’s been said a number of times. What hasn’t been said so much is that although this bill was introduced in February this year—and I want to thank Minister Faafoi for doing so—the need for this bill has actually been noted for at least a couple of years. That’s no criticism of the Government; indeed, it was the previous Government that was considering this just before the last election. So the only reason I say that is it is a long time coming. This bill is needed by the industry. The banks have been asking for this for a very long time. I’m very, very happy to be supporting it this afternoon. I would like to see it passed this afternoon, and that’s why I’ll happily commend it to the House.

This next call is a split call.

People often say they stand up to take some great pleasure to speak on these bills, but, actually, I do take some pride in this in that I have been forced to dig deep into my knowledge of financial matters to understand it. I think, actually, everyone in New Zealand should quite easily understand derivatives, because we just go back to what caused the global financial crisis (GFC). We could sit through—and Mr Andrew Bayly gave us a very good technical description of what they are. But, quite simply put, what you do is you take a whole pile of assets; some of them might be risky, some of them might not. The whole idea of creating a derivative is that the whole product should balance out so when one of the products in the derivative is having a bad day, a bad week, a bad month, a bad year, the other one will be having a good one. So as Mr Bayly said, it’s about taking the risk out.

However, to understand the importance of ensuring that these are well-regulated, these derivatives, go back to what happened in 2008. These derivatives were made up of houses, and the houses were being sold to people who were called “NINJAs”—no income, no job, and I haven’t worked out what the other bit was on the “s”; someone might be able to help me there. But, essentially, it meant that houses were being sold to people at very low interest rates initially who were never ever going to be able to repay the mortgage when the interest rate came to the market rate. So they were fine for two, three, maybe five years, for the time of it. But when the time came to pay them, they were never going to be able to pay them. They were always going to be in default.

Now, the theory was that that was fine because for every bad loan, every “NINJA” loan, there would be a good loan, so these were safe. You could market these things around the United States, market them around the world. They were given by the rating agencies—Standard and Poor’s and the others—very good ratings, triple A ratings. So everyone thought they were buying this nice, safe derivative. Well, actually, what happened was that every single one of the products that made up these derivatives—which could go up for $100 million worth of derivatives—was bad. So when the American housing market collapsed, the whole derivative market collapsed. All of a sudden this nice bit of paper, this nice derivative that you had—and you thought, “Wow, this is worth millions, maybe billions.”—actually wasn’t worth the paper it was printed on.

So that is why this piece of legislation is very important. It is so that when people do—either directly; or indirectly, through their bank, through their investment adviser, or whatever—enter this highly sophisticated market, they have some understanding of what it is that makes up that particular derivative they’re investing in. But that’s unlikely, because we saw, following the GFC, just how hard it was to unravel these things. I think, from memory, one person somewhere in New Jersey went to jail at the end of it. No one else was held accountable. The American taxpayer bailed out the banks and the other financial institutions and everyone has gone on wonderfully since.

So that brings us to this piece of legislation, the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill, which, of course, is to bring New Zealand into line internationally so that there can be some comfort that people who are either directly or indirectly investing in the derivatives market will know that that product that they’re buying is what it is supposed to be. It is a hedge; it is some sort of bringing together, some countering the risk so that, ultimately, the potential bad stuff should potentially balance the potential good stuff.

So when we look at what it is meant to do: it will allow New Zealand entities to meet 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.

We can only hope—I mean, there is nothing certain; we know that just over the weekend, with President Trump’s on-again off-again trade war with China—that those sort of decisions, which may bring amusement to those watching Fox Television or CNN or BBC or even our own television here, are just the musings of a man who has become quite an entertainment in the political world. However, those decisions come right down to what we are trying to do here today. So I commend this bill to the House.

It’s my pleasure to speak in this third reading of the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill. I congratulate the Minister, Minister Faafoi, on bringing it to the House.

For me, it’s quite a simple piece of legislation. What it really means is that we are able to operate within international laws, and we as a nation, and our banking institutions, are able to operate with the best codes around the world. I agree with the previous speaker, Greg O’Connor, that a lot was learnt in the global financial crisis. A lot was learnt with derivatives, subprime mortgages, and all sorts of things called swaptions and all those other types of things that for most New Zealanders wouldn’t make a lot of sense. But, effectively, they are a risk management tool. As the last speaker said, usually in a risk management tool one side of the risk wins and the other side loses. What this piece of legislation really does is bring us into line with international best practice and a global recognition of a series of regulations that we need.

This side of the House is prepared to support this, has been happy to support it, and, in fact, started much of the work on this. It’s my pleasure to commend it to the House at this third reading.

One of the interesting characteristics of the speeches this afternoon is that each person has been explaining a little of what this bill is about. It’s like a group of people in a darkened room, where there is a statue in the middle and no one quite knows the shape but each person shines a light on it from a different angle. Between us all, we are telling the whole story of what is going on with this bill and enabling people to understand it.

It is actually quite a short bill; it’s only 19 pages. As bills go in this House, it’s not a particularly long one. But it is complicated, not in terms of what it does, as Mr Yule has pointed out—because what it does is it brings us into line with our international markets—but in terms of the types of transactions it deals with. I thought that for the benefit of people listening, I would try to bring it back to a very practical example of what one of these derivatives is and why they can be so complicated.

A derivative: futures, swaps—let me explain a future. The first recorded futures are actually from the Dojima Rice Exchange in Japan, in about 1710, so they’re quite an old form of financial instrument. But the ones that we are really familiar with these days derive from the Chicago Board of Trade, which was first set up in 1848. The first futures trades were on corn. Essentially, what would happen is that a farmer, a corn-grower, would agree, say, in spring—and that would, of course, be in April in the United States—that come the Autumn, he—and it probably was a he—would sell his crop for a certain price. So he would get the money right then in April, and come August, he would actually have to hand his crop over. So, in essence, he would put a price on it in April, for delivery in August. That was the futures contract. It sounds very simple. Indeed, futures are quite simple in that respect, but they involve a bet on the future.

So for the people who are trying to understand what goes on with these complicated sorts of financial instruments, think of them as a bet—a bet like a bet at the horse races, where you’re not quite sure what the outcome is going to be. If you’re a good punter, then you’ve probably got a pretty good chance of bringing home some of the money. The problem is when these bets get piled one on top of the other. So imagine that as a punter, a punter might go and place a bet on a horse race at the TAB—come Melbourne Cup day, I’m sure many of us will be doing that—but then she perhaps might go and place another bet on a different horse, and one bet would counter the other a little bit and spread the risk a bit. But then imagine that the punter, in addition to doing that, might go and make a little casual investment, as we often do in our office sweepstake on Melbourne Cup day, and spread the risk a little bit further. But then imagine that that punter, on top of that, says to her mate, “Actually, I’m going to sell you the proceeds of my bet. We don’t know what it’s going to be, but here’s my bet. Here’s my betting ticket, and I’m got to sell it to you for $1. I don’t know what the outcome is going to be yet.” So you add another layer on to the bet. That’s what’s happened with derivatives and that’s what happened in the 2008 global financial crash. As my colleague Mr Greg O’Connor explained, layer upon layer of complexity was added on to these really quite simple bets, and when the original bets didn’t pay off, the whole structure came tumbling down.

I think a little bit of extra explanation is needed here. The whole structure came tumbling down because too many of the punters didn’t have any skin in the game. They didn’t have any skin in the game because in this great, complex world of financial trading, no money actually swapped hands. No one actually had to pay anything over. So in the wake of the global financial crisis, one of the responses that were put into place was to say that around derivatives trading, around trading these complicated futures and swaps and the like, an actual margin—a little bit of the earnings—actually had to change hands and be at risk in any transaction. So it brings an element of reality to what was going on in those very complicated derivatives markets.

Every player in those markets now has to have some skin in the game—that is the rule that is required in the international markets. For New Zealand to be able to participate in these markets, as Mr Yule pointed out, we need to ensure that people here in New Zealand also have skin in the game. So it enables our traders to participate in those international markets. It’s a critical part of our liquidity and the way we manage our liquidity.

There is another issue that was dealt with by this particular bill, and that’s to do with, well, the LIBOR—and everyone goes, “What on earth was the LIBOR?” It was the London Inter-bank Offered Rate. What it did was—it was a way of setting interest rates, and it depended on banks self-reporting what interest rates they thought ought to be underpinning the market. Once you had that rate underpinned, then people in that market could go ahead and trade and understand what was going on in the market. So, you know, the banks would submit an interest rate and give a picture of the health of the system. The system operated on trust, and often systems operating on trust can do very, very well, but in this case the sums of money at stake were such that people took advantage of it and manipulated the LIBOR, the London Inter-bank Offered Rate. So part of what this bill does is it ensures that instead of having a system that operates just on trust, in fact, the way that rate is set is determined by actual bank rates. It has to be set no longer on trust but in a certified way. Again, that’s what’s required by the international markets, and this particular bill brings New Zealand into line with those international markets.

It sounds like small things. It is quite complicated to understand this law. I think all of us had to work quite hard to get our heads around it, and I wish to offer a huge tribute to the officials who guided us through this. It is challenging legislation because it is actually difficult to understand, and it was difficult to get our heads around it, but the officials guided us through it very nicely indeed and turned what for many people can be financial gibberish into quite plain English and helped us to understand what was going on. So a big tribute to those officials, and it was a combination, as always, of the officials’ work, the work of the Minister, the work of the Finance and Expenditure Committee, and members of the select committee from all parties on that committee. We worked on this bill together, and I think we’ve come to a very good outcome. Madam Speaker, I commend this bill to the House.

Tēnā koe, Madam Speaker. Tēnā koutou katoa. I thank the member across the House for a very clear and simple rendition of all this. I myself, who was not a part of the Finance and Expenditure Committee, will strive to speak to the bill in broad strokes as best as I can. So I speak to the Financial Markets (Derivatives Margin and Benchmarking) Reform Amendment Bill.

New Zealand banks use offshore and domestic finance to fund their activities. They enter into derivatives contracts to hedge on the exchange risk of raising money in foreign entities. Other large public sector managers—ACC, the New Zealand super fund—also use derivatives for hedging purposes. Large non-financial corporates also use derivatives. The current value of the big four of New Zealand banks’ derivatives activity would be impacted if this bill were not passed. Currently, it’s around $8.7 trillion annually, and with the outstanding notional amount of cross-country currency basis swaps contracted against international counterparts, it’s around $90 billion across the big four banks.

This omnibus bill seeks to amend several Acts to achieve mainly two primary purposes, two objectives: to ensure that New Zealand financial market participants can continue to participate in international financial markets, particularly by using derivatives to hedge their risks; and also to bring New Zealand law in line with financial market reforms in the European Union and G20 States. The National side supports the bill, and we support all reforming legislation so that banks are not impeded in any way from complying with international requirements in relation to over-the-counter derivatives. These reforms are needed to ensure the ongoing soundness and efficiency of our banking system. Our banks need access to capital, and our regulations shouldn’t prevent them from complying with international best practice, and this is what the bill allows them to do. We also support the need for a licensing regime, as it is the only way to ensure continued access for New Zealand benchmark users to European financial markets.

The G20 rules require that parties to over-the-counter uncleared bilateral derivatives provide security, also known as “margin”, under a derivative contract to support the contract. If one party fails to honour its obligation under the contract, the other party can call on the margin to shield it from any losses that may result. The G20 reforms were introduced as a way of reducing systemic risk in international derivatives markets that contributed to the global financial crisis, as many have already mentioned. There are certain features of New Zealand’s insolvency, statutory management, and personal property security laws that may impede banks’ ability to comply with the margin requirements. In particular, these laws restrict the ability of entities to post margin that the other party, through the derivative contract, can call upon immediately in the event of a default by the posting party. Inability to comply with margin requirements may restrict affected New Zealand entities’ access to overseas derivatives markets and their ability to hedge the exchange risk of underlying funding. For this reason, we find that the bill greatly supports this continued access by New Zealand banks, and we commend this bill to the House.

Thank you, Madam Speaker. Can I thank members from all around the House for their contributions. I didn’t get to kick off this debate but am responsible for the piece of legislation and I just wanted to have the opportunity to thank a number of entities—first of all, the industry, for working collaboratively with a number of Government agencies, primarily the Ministry of Business, Innovation and Employment (MBIE) and the Reserve Bank—and also to commend the Finance and Expenditure Committee, led by Michael Wood, I believe, at the time, for going through this piece of legislation.

There isn’t going to be any print stopping for this piece of legislation when it is finally passed in all of about two minutes’ time, but it is one of those pieces of legislation that is very much needed to ensure that things continue as most New Zealanders would like. There have been a number of quite good attempts, I think, to explain what is a very complex bill in very simple terms, and I want to thank members—Andrew Bayly did a very good job, and also my colleague Deborah Russell did a very good job—for explaining to those people who may have been listening to this debate about what is going on with this piece of legislation. I wish that they had been there when I was first getting a briefing on this piece of legislation, but, having said that, I’ll try and do a little bit of that myself, because people may still be confused.

I think the best example is our banks, and they need to go overseas to acquire capital for the likes of New Zealanders to borrow. For those banks to be able to do that these days, given the events of the global finance crisis, there are conditions that the EU and G20 nations have put on, essentially, overseas lending. We have, by this legislation, started to comply with those decisions, with those regulations, because, quite simply, if we hadn’t, we would have been out of step with nearly every other nation and we wouldn’t have been able to do business with those who lend to our banks.

Essentially, what this means—and I think this is the best way to explain it, as the previous speaker has—is that these derivatives are used by the likes of banks to be able to hedge against any risks over time as that international borrowing is paid back. If, in the extremely unlikely event that one of those entities that are borrowing overseas were to fall over or to default on one of their payments—if those who have lent the money to, for example, a bank want to be paid as a result of a failure to pay a payment—then the hierarchy or the prioritisation of that entity was a little further down the chain. What this bill does is lift those entities further up the chain to give them more confidence to lend to New Zealand entities if something were to go wrong.

We couldn’t have been out of step with other nations. This legislation ensures that we are in step so that those entities go to those markets on an even footing to get the capital that is required here in New Zealand for our economy to keep ticking. If we hadn’t, getting access to that capital would have been much more difficult and, in plain English, that would have meant it was more expensive for the likes of our banks to get that capital, which may have had an impact on interest rates or lending rates here in New Zealand, which, obviously, everyone in this House did not want to happen.

So, again, can I thank the Reserve Bank and MBIE officials for the fact that we have got this legislation through in good time and without too much drama—again, to the select committee for making some changes that were required and for the pleasure of the House to get this piece of legislation through quickly this afternoon.

Bill read a third time.