Banking

Financial Markets Conduct Bill introduced to Parliament

On 12 October 2011, the Rt Hon Simon Power - Minister of Commerce introduced the Financial Markets Conduct Bill to Parliament.  Mr Power described the Bill as a "once-in-a-generation re-write of securities law in New Zealand".

The Bill's aim is to overhaul New Zealand securities law to improve financial market conduct and restore investor confidence in New Zealand’s financial markets.  The Bill itself is 560 pages long and draws on the findings from the Capital Markets Development Taskforce, along with submissions made by interested parties on a draft bill released by the Ministry of Economic Development for consultation (referred to in our September banking and commercial update).  The effects of the global financial crisis and the failure of finance companies have also been taken into account when drafting the Bill.

The Bill repeals and replaces the Securities Act 1978, the Securities Markets Act 1988 and the Unit Trusts Act 1960, as well as making significant amendments to other related legislation.

A few of the key proposals found within the Bill include:

• Replacing the requirement for issuers to prepare both a prospectus and investment statement with a requirement to prepare a single product disclosure statement tailored to retail investors and place other information on a public register
• Establishing licensing regimes for fund managers, independent trustees of workplace superannuation schemes, derivatives dealers, and peer-to-peer lenders
• Introducing stricter requirements for managed investment schemes, including new duties on fund managers and supervisors and stronger governance requirements
• Establishing an escalating system of liability, starting with basic infringement notices and ending with heavy criminal penalties for the worst conduct (imprisonment for up to 10 years, and fines of up to $1 million for individuals and $5 million for companies).

The Bill can be found here.  Submissions on the exposure draft of the Bill are available on the Ministry of Economic Development website.

Capital adequacy for banks:  Basel III

In December 2009 new global regulatory standards for bank capital adequacy and liquidity were released by the Basel Committee on Banking Supervision and endorsed by the G20 leaders at their November 2010 summit.  These standards are commonly known as Basel III standards and build on the themes of their predecessors – Basel I and Basel II.

While not a G20 country the Reserve Bank is still proposing to adopt some core elements of Basel III relating to capital ratios and definitions of capital.  The Reserve Bank has this month released a consultation paper setting out how the standards might be implemented.  The consultation paper is available here.

The Reserve Bank has also said it separately intends to consult on other elements of Basel III in 2012. The Reserve Bank has also stated that it does not propose to adopt the Basel III liquidity provisions but will retain the Liquidity Rules it adopted in 2009.

The consultation paper sets out the main differences between New Zealand's current requirements and those contained in Basel III as follows:

• The Tier 1 minimum capital requirement has increased from 4% to 6%
• The quality of Tier 1 capital has increased – a larger portion of common equity is required, and the criteria for inclusion in Tier 1 capital have been tightened
• The quality of Tier 2 capital has increased – the criteria for inclusion in Tier 2 capital have been tightened
• Basel III requires that most capital deductions be applied to Tier 1 common equity capital rather than 50% from Tier 1 and 50% from Tier 2 as is often the case under Basel II.

The total minimum capital requirement remains unchanged at 8%.

At this stage the Reserve Bank is anticipating that the revised proposals to the capital adequacy requirements in New Zealand will be implemented by the banks by January 2013.  This is a much shorter timeframe than has been proposed in the Basel III standards, which contemplate that the requirements will be phased in starting in January 2013, to be completed by 2018. 

Although it is expected that banks in New Zealand will be well positioned to meet the capital adequacy requirements, the Reserve Bank has requested that those banks complete and submit a quantitative impact assessment of the proposals by 27 January 2012.  It also requires comments on the consultation paper by that date with a view to releasing a revised draft of the capital adequacy requirements, taking into account submissions received, by the first quarter of 2012.

A particular area of concern will be the treatment of existing capital instruments and the extent to which banks may have to call or replace capital instruments that no longer meet the tougher Tier 1 and Tier 2 capital tests (particularly given the truncated timetable for New Zealand banks to comply with the Basel III standards).

We will keep you advised of developments.

Proposed changes to consumer credit laws

Cabinet has recently released plans to amend consumer credit law.  With the general election pending, no timeframe for implementing these changes has been indicated.  Subject to the result of the election, we expect the Government to release draft legislation for consultation in 2012.

Key changes being considered are:

• Strengthen the Credit Contracts and Consumer Finance Act 2003 (CCCFA) by adding new responsible lending requirements, including:
  -  that the borrower must be reasonably expected to repay the loan without substantial hardship
  -  that the lender must be honest and transparent in dealing with the borrower
• Create a "Code of Responsible Lending"
• Empower the Financial Markets Authority to issue formal warnings and cancel a person’s registration as a financial service provider if they fail to comply with the Code and other relevant legislation
• Provide that borrowers are not liable for the costs of interest or fees if their lender is not registered (as required) on the Financial Service Providers Register
• Amend the CCCFA to stipulate that advertising must not be misleading, deceptive, or confusing and must comply with the Code (and provide for prohibition of advertisements that breach this requirement)
• Protect important goods (e.g. tools of trade, necessary household items and motor vehicles valued at up to $5,000) from being used as security against a loan (except a loan for such items)
• Extend the "cooling-off period" (i.e. the period in which a consumer has the right to cancel a credit contract) from 3 to 5 working days
• Improve disclosure requirements.

See the full press release avaliable here.  We will keep you updated with developments.

Wider access to New Zealand Export Credit Office (NZECO) trade guarantees

Changes are to be made to the rules governing access to the NZECO's trade guarantees. 

The first change is to allow NZECO to underwrite its trade guarantees in a broader range of currencies, including China's renminbi.  This reflects the reality that New Zealand exporters are increasingly under demand from Chinese buyers to transact directly in the renminbi.

The second change is in relation to NZECO's 30% content rule, which requires that exporters' products have at least 30% New Zealand content to be eligible for a trade guarantee.  The change will provide for a wider "benefit to New Zealand test", which takes into account benefits to New Zealand over and above the level of New Zealand value-added content.  Thus, under the wider test, to measure New Zealand "economic benefit" NZECO will look at one or more of the value of goods or services provided from New Zealand (either solely or in conjunction with other New Zealand residents), the profit derived from the transaction that will be repatriated back to New Zealand, the level of intellectual property underpinning the transaction, and the potential to further leverage and grow this intellectual property and the potential for growth into countries and industry sectors considered of strategic economic benefit to New Zealand.

If products are oversubscribed, NZECO will continue to prioritise exports with New Zealand value-added content.  It is anticipated that the changes will take effect later this month.

Newly formed crown company to acquire and administer failed finance companies' assets

Finance Minister, Rt Hon Bill English announced late last month that the Government will set up a company to manage the remaining assets from 6 failed finance companies that were covered by the Crown Guarantee.  The cost of setting up the company will be around $800,000 and it is intended that the company will be operational early in 2012.

The 6 finance companies are Allied Nationwide Finance, South Canterbury Finance, Vision Securities, Mascot Finance, Mutual Finance and Rockforte Finance.  The Government is now the only remaining creditor of each of these 6 finance companies.

Mr English said that the receiverships of these companies have now reached a stage where easily marketable assets have been sold.  One Crown company to manage the remaining assets of each company is expected to reduce administration costs by an estimated $13 million over 2 years.

No further information has been released since the press release on 27 October 2011.  We will update you as further information is released. 

Commercial

When is negligence "gross negligence"

Many liability provisions of commercial agreements use the expression "gross negligence" yet there has been little guidance from the courts as to the meaning of that term.  A recent Irish High Court case considered the expression and, while not binding in New Zealand, is a useful guide to the necessary degree negligence must be to constitute "gross negligence".

The High Court held that gross negligence "is a degree of negligence where whatever duty of care may be involved has not been met by a significant margin." 

In context, the case (ICDL GCC Foundation FZ-LLC v The European Computer Driving Licence Foundation Ltd [2011] IEHC 343) revolved around a licence to use a computer training program in Saudi Arabia.  The defendants terminated the plaintiffs' licence on the basis that they were in breach of their obligation to have all necessary licences or consents to carry on business as required by a term in the licence agreement.  The defendants believed that the plaintiffs were in breach due to information they had been provided by a third party in Saudi Arabia who had an interest in the licence being terminated.  The court held that the defendants had no basis to terminate the agreement as there was no licence that was required by law that the plaintiffs did not have.

Having found for the plaintiffs the question then arose as to whether the limitation of liability clause applied.  The clause limited the liability of the defendants to €50,000 unless there was wilful conduct or gross negligence.  The court held "that business efficacy must be given to the clause" and that the clause would have little effect in this contract unless the courts were able to consider that a breach of contract that resulted from a "significant degree of carelessness" was gross negligence.  Accordingly, the termination of the licence in breach of contract had "resulted from a significant degree of carelessness" and therefore met the test for gross negligence.  The limitation of liability clause did not apply and the defendants were liable to the plaintiffs for the total sum of their loss.

Is your D&O policy adequate?

A recent decision has a significant impact on the interpretation and application of directors and officers insurance (D&O) policies. 

In Steigrad v BFSL 2007 Ltd (Auckland High Court, 15 September 2011, Justice Lang) 3 former directors in the Bridgecorp group sought a declaration from the court that a charge against Bridgecorp's D&O policy arising under section 9 of the Law Reform Act 1936 did not prevent the insurer from meeting its contractual obligations under the D&O policy to reimburse them for defence costs.  The court did not accept this proposition and ruled that because the directors were facing a claim for $450 million, a sum significantly greater than the amount of cover available under the D&O policy (which had an indemnity limit of $20 million), the charge prevented the directors from having access to the D&O policy. 

Because the amount of the claim was more than the insurance fund, the insurer was bound to keep the insurance fund intact for the purposes of section 9.  However, the court noted that the position might have been different where the amount of the claim was less than the insurance fund.  In those circumstances the charge under section 9 would only extend to the likely amount of the claim and the directors may therefore have been able to gain access to the policy to meet their defence costs.

The High Court decision is being appealed and is due to be heard in 2012.  We will keep you advised of developments.  In the meantime, as a result of this decision it would be prudent for all companies to review their current insurance arrangements or talk to their broker/insurer.  To avoid this situation arising in this case, options include:

• Taking out a statutory liability policy (though note that these policies will only help cover defence costs in actions and investigations which involve breaches of statute and will not cover civil claims)
• Increasing the level of cover on your D&O policy to ensure adequate coverage for all likely claims and defence costs
• Taking out a separate defence costs insurance policy.

Finally, we note that while this decision is focused on D&O policies, the reasoning applied could extend to any insurance policy which indemnifies a person against liability to pay any damages and defence costs within the same limit of liability.  Accordingly, general and professional liability policies should also be reviewed against the purposes for which they were taken out to insure adequate cover is in place.  Policies with separate limits for defence costs should not be affected by this decision. 

Oral contracts and implied terms

Hunter Grain Ltd v J Swap Contractors Ltd (HC, Tauranga, CIV-2008-470-837, 12/9/2011, Cooper J) is a useful reminder that in some contexts a binding contract can arise from an oral arrangement.  The decision illustrates the importance of documenting key terms of your commercial arrangements, particularly when those arrangements are material to your business.  It is also a lesson that in the absence of a written contract, a party is not simply free to act without regard to the other party to an existing long-term arrangement.

In this case, Hunter Grain imported palm kernel expeller (PKE), which J Swap then sold and distributed.  The court held that this arrangement was a contractual relationship that arose from a meeting between the parties in 2004.  Things unwound when J Swap began sourcing its PKE from another supplier without giving notice to Hunter Grain.  This was part of a scheme, between a former director and chief executive of Hunter Grain's New Zealand operations and J Swap, "which was designed to remove, and had the effect of removing, Hunter Grain from the PKE supply chain in New Zealand".

Having found an agreement between the parties, the court implied terms that J Swap would not do anything to prevent Hunter Grain from fulfilling its obligations to supply PKE and that reasonable notice must be given before the agreement could be terminated.  A difficult issue was the appropriate length of the notice period, with the court holding that a 4 month notice period was reasonable in the circumstances of the case.  Hunter Grain succeeded on claims for breach of contract and for conspiracy and the court awarded Hunter Grain $4.63 million in damages and interest.

Criminalisation of 'hard-core' cartel conduct – bill introduced

A Bill that proposes to criminalise cartel conduct in New Zealand was introduced shortly before Parliament was dissolved for the 2011 election.  The introduction of the Commerce (Cartels and Other Matters) Amendment Bill follows the release of an exposure draft of the Bill earlier this year (see our July 2011 update available here).

The key features of the Bill are broadly the same as the exposure draft of the Bill.  The key amendments proposed are:

• A new prohibition on entering or giving effect to a "cartel provision" (a provision that has the purpose, effect, or likely effect of price fixing, restricting output, market allocating, or bid rigging), which will replace the current price fixing prohibition in the Commerce Act
• The establishment of a criminal offence for entering into or giving effect to an arrangement that contains a cartel provision (for which the penalties, to come into force 2 years after the Act comes into force, include imprisonment for a term of up to 7 years)
• A new exemption and clearance regime relating to cartel provisions that are reasonably necessary for the purpose of a collaborative activity.

The proposal to include imprisonment as a penalty for offences relating to the Commission's information gathering powers (such as failing to comply with a notice issued by the Commission) has not been included in the Bill.  However, it is proposed that the maximum fines for such offences will be increased to $100,000 for an individual and $300,000 for a body corporate (from $10,000 and $30,000 respectively).

Public submissions on the Bill will be sought when the Bill is referred to select committee, which is likely to be later this year or in 2012.  We will provide a further update at that time.

Further information, including the Bill, is available here.

Important changes to company and limited partnership administration

The Companies and Limited Partnerships Amendment Bill was introduced to Parliament on 13 October 2011.  A fundamental change proposed requires every company and limited partnership to have a director or general partner (as applicable) resident in New Zealand or to appoint a New Zealand "resident agent" who is responsible for the entity's administrative functions.  The resident agent must be a natural person living in New Zealand.  Other changes include:

• Expanding the Registrar's investigative and de-registration powers in relation to companies and limited partnerships (including the ability to include notes about suspect entities that are under investigation in the register)
• Aligning the Companies Act 1993 with the Takeovers Code to restrict the ability of code companies to implement mergers or restructurings under the amalgamation and arrangement provisions of the Companies Act 1993, as opposed to the Takeovers Code
• Criminalising certain directors' duties to act in good faith and in the best interests of the company, and to not carry on business in a way that risks serious loss to the company's creditors (directors who commit these offences will be liable for imprisonment of up to 5 years or fines of up to $200,000).