The Finance and Expenditure Committee has examined the Reserve Bank of New Zealand Amendment Bill (No 3) and recommends that it be passed with the amendments shown.

Introduction

This bill would implement the main elements of the new regulatory framework for non-bank deposit takers—mainly, the matters for which prudential regulations may be prescribed—and increase the Reserve Bank of New Zealand’s accountability and transparency arrangements in relation to its financial sector functions.

This commentary covers the key amendments that we recommend to the bill. It does not cover minor or technical amendments.

Transition period for credit rating requirements

We recommend that clause 2 be amended to provide that the credit rating requirements in clause 11 (section 157I) would come into force 18 months after the commencement of the Act. The bill as introduced provides no transition period to allow deposit takers time to comply with the new credit rating requirements. We are concerned that deposit takers might not be in a position to comply with these provisions immediately, partly since approving rating agencies under new section 157J might take some time.

We trust that eighteen months will prove sufficient time for the bank to approve enough rating agencies to allow most deposit takers to comply with the credit rating requirements. We note that, in the event that deposit takers were still not in a position to comply after 18 months the Bank could grant temporary exemptions from credit rating requirements, under new section 157G, to ensure that non-compliance would not be an issue.

We were told by the Reserve Bank that it expected an initial list of rating agencies to be available in the last quarter of this year.

Advice requested by the Minister

We recommend that clause 8 be amended to clarify that the advice that can be requested by the Minister under this regime must be connected with the functions of the Bank, and to confirm that this advisory function must not limit the Bank in the performance of its primary monetary policy function. This is intended to ensure that the advisory role established under this bill would not compromise the Bank’s independence or the exercise of its primary functions.

Confidentiality

We recommend the insertion of new clause 8A to confirm that information collected by the Bank from non-bank financial institutions must remain confidential to the Bank, unless it is shared in statistical form with persons with a proper interest, or with the consent of the person from whom it is collected. This amendment would ensure that information collected from non-bank financial institutions was accorded a similar standard of confidentiality to that collected from banks and payment system participants.

The new regulatory responsibilities of the Bank proposed in this bill, along with its expanded policy advisory services and the new requirement that it produce a financial stability report, would mean that the Bank would be collecting more information from non-bank financial deposit takers than ever before. It is important that the information collected be subject to appropriate confidentiality protections.

Conflict of interest restrictions

We recommend the insertion of new clauses 8B, 8C, and 8D, which would prevent the Governor and Deputy Governor of the Bank from holding interests in deposit takers. The Governor and Deputy Governor are already prevented from holding interests in a registered bank. This restriction recognises the conflict that could arise should they do so, given their roles and responsibilities. In the regime proposed by this bill, the Bank would gain wide discretion over matters such as exemptions and prosecution of breaches, and the potential for similar conflicts might arise. This amendment would help to prevent conflicts of interest arising for the Governor or Deputy Governor in relation to non-bank deposit takers.

Application of the regulatory regime

Clause 11 inserts new part 5D into the Reserve Bank of New Zealand Act 1989, which relates to the regulation of deposit takers.

We recommend a number of amendments to the definition of “deposit taker” in clause 11 (section 157C). This definition is vital in determining the application of the regime. We recommend that the definition be extended so that a person who had offered debt securities to the public that remained unpaid could be subject to the regime. We considered whether issuers of collective investment schemes should be included also, but decided that the business in which these issuers are engaged does not lend itself conceptually or practically to regulation under the bill.

The definition allows groups to be excluded from, or included in, the regime by Order in Council (157C(4)). We recommend an amendment, in section 157C(5), to ensure that the power to exempt or include could be targeted according to the nature of the business undertaken. We are concerned that individuals or organisations whose primary business is not related to deposit taking, such as hire businesses that accept deposits as security for the return of goods, could be unintentionally captured by the regime. Conversely, those who are not typical deposit takers, but whose business is analogous to deposit taking, might be inadvertently excluded. The addition of a test to the effect that the regime should apply when the nature of a business is analogous to deposit taking would help to ensure that the regime was appropriately applied in such circumstances.

Exemptions

Consultation

We recommend that clause 11 be amended to remove from new section 157E(1) the requirement for the Bank to consult when granting an exemption from regulatory requirements. We consider consultation an unnecessary administrative inconvenience in relation to the granting of exemptions, as it is extremely unlikely that anyone would not wish to be exempted (the consultation would serve no purpose). Consultation would still be required before inclusion in the regime (which is effected through regulation).

Criteria for exemptions

We recommend that clause 11 be amended so that section 157G specifies the tests that must be met before an exemption could be granted. The bill as introduced allows the Bank discretion to grant exemptions without fetter. We are concerned that this could result in inconsistent decisions by the Bank, and uncertainty for people potentially subject to the regime. The amendment we recommend would provide clear guidance for the Bank and certainty for potential subjects, and is intended to help ensure consistent treatment under the regime.

We recommend minor amendments to make it clear that exemptions could be granted only to deposit takers and their trustees, and that the Bank must provide reasons for imposing terms and conditions on an exemption.

We examined whether the Bank needs the ability to make an exemption from all obligations. We recognised the possibility that allowing “blanket” exemptions might increase the risk of hasty or ill-considered decisions. However, we accept that in some instances a blanket exemption might be appropriate, for example for a supranational such as the World Bank. We trust that the discretion the bill would allow the Bank would be used sparingly and wisely.

Principles on which the Bank acts

We recommend amendments to clause 11 (in sections 157F and 157J) to ensure that the principles on which the Bank must act when carrying out its responsibilities under the bill are clearly set out. The bill as introduced requires only that the Bank publish the principles on which it might act, without specifying those principles. We consider it vital that the rationale behind the exercise of the Bank’s powers under the regime be clear, and therefore recommend that the key principles be clearly laid out in the bill.

The principles set out in new section 157F would apply to the Bank’s powers to grant exemptions and impose terms and conditions on exemptions, its power to recommend regulations, and the principles that the Bank would need to take into account when deciding whether to approve a rating agency would be set out in section 157J.

We examined the desirability of amending section 157ZU, which sets out matters relating to regulation-making powers, to provide for equality of treatment of non-bank deposit takers in the application of regulations except where the application of different requirements was required on the basis of objective risk assessment. However, we consider that the principles we recommend including in section 157F adequately emphasise the need for organisations to be treated fairly and equally where appropriate, whilst recognising that outcomes for organisations could vary according, for example, to the level of risk they expose themselves to.

Risk management and governance requirements

We recommend amendments to clause 11 to ensure that governance and risk management requirements are included in the primary legislation. The bill as introduced allows these matters to be established through regulation. We consider it more appropriate that basic requirements for governance and risk management be laid out explicitly in the bill.

The amendments we recommend to governance requirements, contained in new section 157L, would require the governing body of a deposit taker to include at least two independent directors (who were not employed by, nor had an ownership interest in, the deposit taker or related entities) and to ensure that the chairperson was not an employee of the deposit taker or a related party.

The amendments we recommend in relation to risk management requirements, contained in new section 157N, would require non-bank deposit takers to have a risk management programme that the trustee considered appropriate. We examined whether it would be useful to include content requirements in the legislation, but decided that appropriate risk management programmes for the range of organisations this regime might apply to are likely to be too diverse for encapsulation in legislation. We were assured by the Reserve Bank that it would provide guidelines for organisations to assist them in understanding risk management concepts and requirements, and expect this to help organisations to develop risk management programmes tailored to their needs.

We recommend amendments to clause 11, in section 157ZP, to provide that non-compliance with risk management provisions would be an offence.

We recommend amendments to clause 2 to provide for a transition period before the governance and risk assessment requirements come into effect. This would allow organisations time to comply with the requirements we recommend.

Obligations of trustees to Reserve Bank

Materiality of non-compliance

We recommend amendments to clause 11 to clarify that, under new section 157ZE, trustees would be required to report only material non-compliance on the part of non-deposit-takers to the Bank. The bill as introduced does not qualify the kind of non-compliance that must be reported. The amendment we recommend would ensure that immaterial non-compliance, such as technical non-compliance with no serious or ongoing implications, need not be reported. This amendment is intended to avoid unnecessarily onerous obligations on trustees, and administrative difficulties for the Bank.

We consider a test of materiality appropriate, and do not consider it desirable to define this term further, as we acknowledge that in some cases seemingly small compliance issues could be of import. For example, if an organisation were two days late in producing a risk management plan, this is likely to be immaterial as regards whether a plan had in fact been produced. However, it might be material if the organisation had just collected a number of deposits. We expect materiality to be judged case by case, and trustees to exercise judgment and common sense when determining whether a matter is material.

Reasonableness test

We recommend an amendment to clause 11, in section 157ZF, to include a test of reasonableness regarding whether an opinion has been formed. The act of “forming an opinion” triggers the requirement that a trustee disclose information to the bank. The bill as introduced provides that the trustee obligation arises only when the trustee has formed an opinion, and is silent on what should happen when the trustee is aware of facts on which they should have reasonably formed an opinion. We consider that the correct trigger is whether a trustee has formed an opinion or should have reasonably formed an opinion, and recommend this amendment accordingly.

Cost of an investigatory report

We recommend an amendment to clause 11 to make it clear in section 157ZH that, where the Bank requests that a copy of a report relating to a deposit taker be prepared by an approved party, the costs of the report must be borne by the deposit taker. We considered this amendment carefully, as we wanted to ensure that in practice this amendment could not be used to unduly distress or disadvantage a deposit taker already under pressure.

The Reserve Bank assured us that, although no explicit limits are set in the bill on the exercise of this power, it would be used only as a last resort when the trustee had not been able to obtain the necessary information for the Bank, or when the trustee was not co-operating with the Bank. We were told that the power would be invoked after other avenues had been exhausted, and where the Bank had reasonably formed an opinion that non-compliance was likely. The Bank also assured us that the operation of this power would not interfere with the role of trustees or receivers, and that the application of the power would be governed by the general requirement that the Bank act with a proper purpose. The Bank noted that requirements for confidentiality, which would be contained in new section 157M, would apply to all information gained by using this power.

Search warrants

We recommend an amendment to clause 11 to provide, in new section 157ZL, that a search warrant can be issued by a District Court as well as the High Court. The bill as introduced allows search warrants under the regime to be issued by the High Court only. We consider that allowing search warrants to be issued by the District Court has administrative advantages, and we see no reason that it should not be able to do so.

Legal privilege

We recommend an amendment to clause 11 to insert new section 157ZLA. This amendment would ensure that the legal privileges that would apply in relation to enforcement powers would be consistent with those that apply for evidentiary purposes in proceedings, and would accord with the recommendations of the Law Commission in its Report on Search and Surveillance Powers [NZLC R 97, 30 June 2007]; it would entail a consequential amendment to the reference to legal privilege in section 157ZJ as drafted.

Confidentiality of information

We recommend that clause 11 be amended to expand the confidentiality provisions in section 157ZM, to cover information once it has been disclosed by the Bank to the Registrar and the Securities Commission.

Statutory defences

We recommend that clause 11 be amended by inserting new section 157ZQA, which would provide statutory defences for deposit takers where contravention was due to the actions or default of another person, or in any other way beyond the defendant’s control, and the deposit taker took reasonable precautions and exercised due diligence to avoid the contravention. We consider these fair and reasonable defences to the offences contained in the bill. We also recommend the insertion of new section 157ZQB, which would confirm a court’s power to discharge a defendant where the alleged contravention was in respect of matters that are immaterial.

Regulatory impact statements

We recommend a number of amendments to clause 13 to the requirements for regulatory impact statements in section 162AB, including amendments to clarify that the Bank’s assessment of regulatory impact statements should precede the adoption and application of the policies, and to provide that the Bank must publish every assessment report unless the policy is of a minor or technical nature. Information that is commercially sensitive would not need to be published. These amendments are intended to ensure that assessments can be given practical effect by the Bank, and to increase transparency and accountability throughout the regime. We also recommend amendments to clarify that regulatory impact statement assessments are not required for policies that are minor and technical in nature, to avoid an unnecessary administrative burden.

Review of regime

We recommend clause 11 be amended by inserting new section 157ZUA, which provides that the regime (inserted by clause 11 of this bill) must be reviewed within five years of commencement. The findings of the review would be reported to the Minister of Finance, who would in turn be required to present a copy of the report to the House. We consider such a review desirable given the novelty of some features of the regime, such as the use of trustees, and that the threshold for the credit rating requirement would be set by delegated legislation.

Calculation of annual dividend

We recommend the insertion of new clause 12C and an amendment to clause 15, which would change the way that the Bank was required to calculate its annual dividend to the Crown. At present, the Bank calculates this dividend in accordance with a legislative formula. This formula-based determination does not always reflect changes to the Bank’s balance sheet, market, and accounting, and in recent years has not accurately reflected the amount that should be available for distribution in an economic sense. The amendments we recommend would allow the Bank to determine the principles, which must be published in its Statement of Intent, upon which it would recommend the dividend. The Minister would continue to be responsible for finally determining the amount of the dividend, taking into account the recommendation of the Bank and the views of the Bank’s Board.

Financial stability reports

We recommend an amendment to clause 19, section 165A, to allow some flexibility in the timing of the Bank’s issuing of financial stability reports. We expect them to be issued approximately every six months.

Definition of terms

We considered recommending amendments to define some of the terms in the bill, such as “capital” (clause 11, section 157P), “exposures” (clause 11, section 157ZU), and “framework” (clause 11, section 157V). We decided not to do so, however, as these concepts are technical and can change over time. We note that some concepts, such as capital, will be effectively defined through regulations, which would allow flexibility that definition in the primary legislation would not.

Appendix

Committee process

The Reserve Bank of New Zealand Amendment Bill (No. 3) was referred to the committee on 12 December 2007. The closing date for submissions was 15 February 2008. We received and considered 17 submissions from interested groups and individuals. We heard 8 submissions.

We received advice from the Reserve Bank of New Zealand, the Treasury, and an independent specialist adviser. The Regulations Review Committee reported to the committee on the powers contained in clause 11 (sections 157L, 157N and 157G).

Committee membership

Charles Chauvel (Chairperson)

Hon Bill English

Jeanette Fitzsimons

Craig Foss

Hon Mark Gosche

Hone Harawira

Rodney Hide

Moana Mackey

Dr the Hon Lockwood Smith (Deputy Chairperson)

Hon Paul Swain

Chris Tremain

Judy Turner

R Doug Woolerton

Key to symbols used

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Hon Dr Michael Cullen

Reserve Bank of New Zealand Amendment Bill (No 3)

Government Bill

174—2

1 Title

2 Commencement

3 Principal Act amended

Part 1
Amendments outside Part 6 of principal Act

4 Long Title repealed

5 New section 1A inserted

1A Purpose

5A Interpretation

6 New section 16 substituted

16 Dealing in foreign exchange by Bank

7 Foreign reserves

8 New section 33 substituted

33 Policy advice

8A Bank may require financial institution to supply information

8B Disqualification of Governor and Deputy Governor

8C Removal of Governor from office

8D Removal of Deputy Governor from office by Order in Council

9 Duties of Board

10 New section 68B inserted

68B Bank to have regard to directions about government policy objectives

10A Further matters that may be prescribed

11 New Part 5D inserted

Part 5D
Deposit takers

Preliminary provisions

157A Exercise of powers under this Part

157B Interpretation

157C Deposit taker defined

157D Application of Part

157E Bank to consult before recommending making of regulations under this Part

~~157F Publication of principles~~

157F Principles to be taken into account under this Part

157G Exemptions from Part

157H Effect of exemption

Credit ratings

157I Deposit taker must have current credit rating

157J Bank may approve rating agencies

157K Regulations relating to credit ratings

Governance requirements

~~157L Regulations may prescribe requirements for governance of deposit takers~~

157L Governance requirements

~~157M Deposit taker must comply with governance requirements~~

Risk management

~~157N Regulations may prescribe requirements relating to risk management~~

~~157O Deposit taker must comply with risk management requirements~~

157M Deposit taker must have and comply with risk management programme

157N Risk management programme must be provided to trustee and must be amended if required by trustee

157O Trustee may require deposit taker to have risk management programme audited

Minimum capital requirement

157P Trust deed must set out minimum capital that deposit taker is required to maintain

157Q Deposit taker must maintain not less than minimum capital prescribed

Capital ratio requirement

157R Regulations may impose requirement that trust deed includes capital ratio

157S Deposit takers and trustees must ensure capital ratio included in trust deed

157T Deposit taker must maintain capital ratio required to be included in trust deed

Restrictions on related party exposures

157U Regulations may impose requirement that trust deed includes maximum limit on exposures to related parties

157V Regulations may incorporate by reference framework for calculation of maximum limit on exposures to related parties

157W Deposit takers and trustees must ensure maximum limit on exposures to related parties is included in trust deed

157X Deposit taker must not exceed maximum limit on related party exposures

Liquidity requirements

157Y Regulations may impose requirement that liquidity requirements be included in trust deed

157Z Deposit takers and trustees must ensure liquidity requirements are included in trust deeds

157ZA Deposit takers must comply with liquidity requirements in trust deeds

Other matters relating to trust deeds

157ZB Amendment to trust deed must be treated as if authorised to be made

157ZC Trustee may execute amendment to trust deed

Obligations of trustees to Bank

157ZD Bank may require trustee to attest as to deposit taker’s compliance with requirements

157ZE Trustee must report to Bank non-compliance or likely non-compliance by deposit taker

157ZF Obligation on trustees to disclose information to Bank in certain circumstances

157ZG Protection of trustees

Investigation and enforcement powers of Bank

157ZH Bank may require report relating to deposit taker

157ZI Power to obtain information and documents

~~157ZJ Limitations on information required to be provided~~

157ZJ Limitation on information to be provided

157ZK Limitations on entering and searching place

157ZL Search warrant may be issued

157ZLA Privileges

Confidentiality of information

157ZM Confidentiality of information

157ZN Person who does not comply with section 157ZM commits offence

157ZO Application of Official Information Act 1982, etc

Offences and penalties

157ZP Offences by deposit takers against this Part

157ZQ Other offences by deposit takers against this Part

157ZQA Defence for deposit takers charged with offences against this Part

157ZQB Power of court to discharge deposit taker

157ZR Liability of directors

157ZS Offences by trustees against this Part

157ZT Penalties for offences

Miscellaneous

157ZU Matters relating to regulation-making powers under this Part

157ZUA Bank must review and report on operation of this Part

Part 2
Amendments to Part 6 of principal Act

12A Section 158 repealed

12B Funding agreements

12C New section 162 substituted

162 Determination of annual dividend

12 New Part 6 heading substituted

Part 6
Financial and accountability matters

13 New heading and sections 162AA and 162AB inserted

Accountability documents

162AA Purpose of accountability documents

~~162AB Assessment of regulatory impacts of policies~~

162AB Assessment of regulatory impacts of policies

14 New heading inserted

15 Content of statement of intent

16 Process for providing statement of intent to Minister

17 New heading inserted

18 Annual reports and accounts

19 New heading and section 165A inserted