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Disclosure rules for financial intermediaries in New Zealand

3.5 Review of disclosure rules in Australasian banking

3.5.1 Disclosure rules for financial intermediaries in New Zealand Company legislation and accounting standards

From the start of the observation period up until the mid 1990s, companies reported under the Companies Act 1955. As a fundamental principle, the act required that every balance sheet and profit and loss account of a company should give a “true and fair view” of the state of affairs (s 153(1)). Rules regarding the form of accounts were laid out in Schedule 8 to this act and were very general in form. Disclosure requirements that touched on the reporting of credit losses were the obligation to show the impairment of assets but specifically just for fixed assets ("Companies Act 1955" Eight Schedule, cl 11(1)) and the need to show provisions and reversals in a broad sense if they were material (cl 13.1 (g)).

At the time, there were accounting standards in force – then named ‘Statements of

Standard Accounting Practice’ (SSAP) and issued by the Council of the New Zealand Society of Accountants (NZSA) – on the basis that members of the society were required to comply with them or to disclose departures, in accordance with specified criteria.48 None of the SSAPs related however to the specifics of the reporting by financial institutions in general, or loan loss

provisions in particular. Some of these standards helped push banks towards greater disclosure of credit provisions as for example SSAP-9, issued in 1978 (cl 4.1 (c)), which bans material items from being included with or offset against other items without separate identification. Pre-1980, loan loss provisions, though material in most cases, had been offset against loans while

provisions expense had typically been netted against gross revenues by the banks.

A major reshuffle of company legislation in the New Zealand occurred with the enactment of the Companies Act 1993 which is still in force today.49 Unlike the Companies Act 1955, the

48 See Zeff (1979) for a more historical perspective of how accounting principles have evolved in New Zealand.

49 Mortlock (2003, p. 16-19) provides a concise summary of the philosophy and workings of New Zealand’s current financial and accounting system which includes the financial reporting and auditing framework.

1993 Act no longer contains any requirements relating to the contents of financial statements but these issues were addressed in the Financial Reporting Act 1993. Not all banks started reporting immediately under the new act as there was a 3-year transitional period to the mid of 1997 during which both acts were in force.

The Financial Reporting Act 1993 represented a new approach to legislating the way companies have to disclose information in that the act does not define reporting rules per se but requires reporting to comply with generally accepted accounting practice set by the Accounting Standards Review Board (ASRB), which itself is established through this act (III, ss 22-35). The process is that the NZSA, later renamed Institute of Chartered Accountants of New Zealand (ICANZ) submits these standards to the ASRB for approval which thereby makes them legally binding.

The number of financial reporting standards (FRSs) has grown through the years, at the same time replacing the previous SSAP standards.50 Standards relating to the reporting on credit provisions and losses may be found in

• FRS-9 - Information to be Disclosed in Financial Statements (ICANZ, 1995),

• FRS-31 - Disclosure of Information About Financial Instruments (NZSA, 1982),

• FRS-33 - Disclosure of Information by Financial Institutions (ICANZ, 2000).

As a final note, a major reshaping of accounting standards is on its way at the time of writing. This relates to the introduction of the New Zealand equivalents to International Financial Reporting Standards (NZ IFRS) which are currently being phased in.51 A new set of rules will replace above the FRSs, in particular,

50 While standards were renamed from SSAP to FRS, they kept the number of the older SSAP standard for a particular subject field. For example, both SSAP-9 and FRS-9 deal with standards for disclosure in financial statements.

51 Entities are permitted to use NZ IFRS in the preparation of financial statements for periods commencing on or after 1 January 2005. These standards will become mandatory for reporting periods commencing on or after 1 January 2007 (ICANZ, 2005a, s 13, p. 7).

• FRS-9 by NZ IAS 1 (ICANZ, 2006),

• FRS-31 by NZ IAS 32 (ICANZ, 2005b) and , finally,

• FRS-33 by NZ IAS 30 (ICANZ, 2004).

Rules regarding ‘impairment and uncollectibility of financial assets’ will no longer be covered in FRS-33, however, but in NZ IFRS 39 - Financial Instruments: Recognition and Measurement (ICANZ, 2005c). Under the new provisioning rules, the concepts of specific and general provisions are discontinued and replaced by the new categories of individual and collective impairment (KPMG, 2005, p. 22).52 These changes will, however, have no effect on the historical provisioning data which have been reported under earlier rules and standards. Prudential regulation of New Zealand banks

Given the public interest to safeguard the financial system, banks operating in New Zealand have always been subject to particular regulation and supervision beyond the general company legislation. Before the financial deregulation starting in the mid 1980s, legislation dealing with banks, e.g. as laid out in the Reserve Bank of New Zealand Act 1964 ("Reserve Bank of New Zealand Act 1964"Part V: Regulation of Banking and Credit) was less concerned with prudential supervision of the banks per se but contained direct prescriptive authority of the RBNZ over the operations of financial institutions, i.e. very much in the spirit of the time with pervasive regulations in almost every sector of the economy. Prudential aspects were indirectly addressed by RBNZ’s right to impose so-called reserve ratios, i.e. a requirement to hold a certain

52 In future, there will be less discretion in the provisioning of unidentified losses and financial assets may be regarded as impaired only if there is objective evidence to this effect as a result of past events. There is uncertainty as to the interpretation of these new rules as shown, for instance, in Westpac’s NZ disclosure statement per September 2005 (p. 26), which expects reduced provisions but states that ‘the extent of this reduction in provisioning has not yet been determined as a result of unsettled interpretation issues’. In general, the market expects banks’ earnings volatility to increase.

percentage of borrowings as deposits with the RBNZ or government stock. The main purpose of these ratios lay in monetary policy implementation. Grimes (1998, p. 298) points out that such rules had the opposite effect of prudential requirements in 1984 when it left some savings institutions technically insolvent when a sharp rise in interest rates caused the market value of their long-term government securities to fall markedly.

A formal prudential framework came into force only with the 1986 Reserve Bank of New Zealand Amendment Act, subsequently replaced by the 1989 Reserve Bank of New Zealand Act 1989 (still in force today). For the first time, it defined the role of the RBNZ as a prudential regulator and supervisor of the banking system. Accordingly, these acts introduced a new

registration process for banks and defined prudential regulation and supervision as a specific role for the RBNZ. Powers of the RBNZ under these acts are still extensive but the 1986 Amendment Act had no provisions of forcing relevant information disclosure to the banks’ depositors. The 1989 Act ("Reserve Bank of New Zealand Act 1989"s 81) then provided RBNZ with the explicit mandate of prescribing information to be disclosed by means of ‘disclosure statements’.

The 1989 Act had no immediate effect, however, as the required regulation defining the content of these disclosure statements was issued only in 1995 (RBNZ, 1995 Registered Bank Disclosure Statement Order). The issuance of the 1995 order, whose implications are

summarized in Mortlock (1999), coincided with a change in RBNZ application of its powers under the 1989 Act and a shift to a comparably light-handed disclosure based regime of banking supervision. This included a shift in focus to ensuring proper disclosure to the market away from obtaining direct information from banks or even interfering with a bank’s affairs. More recently, the RBNZ has become slightly more intrusive. Since 2003 essentially all the country’s main banks have been owned by the four leading Australian banking groups and this has given rise to concerns regarding potential effects of financial contagion spreading from Australia (see for example research by Hull, 1999). RBNZ has thus acted by imposing limits on outsourcing essential core bank functions to their parents for systemically important institutions (RBNZ,

2006b). It has also forced Westpac, which had been operating as a branch bank in New Zealand since 1861, to seek local incorporation, at least for its retail activities.

Both the 1995 Order mentioned above and its 1998 revision (RBNZ, 1998 Order in Council) have nevertheless brought uniformity into the banks’ information disclosure and New Zealand’s market discipline based approach to regulation is often cited as a model in

international publications (e.g. in Gup, 2000, p. 189-190; e.g. in Mayes, 2000). The orders lay down the form, content and frequency of bank disclosure statements in great detail. Specific disclosure requirements relate to asset quality (various types of impaired assets, specific and general provisions, asset write-offs), risk concentrations (credit, funding, individual, connected counterparties), and general credit information (guarantee and ownership, credit ratings, relevant accounting policies). There are also rules on how to present information on the bank’s capital ratios in the Basel capital adequacy framework (BCBS, 1988). The 1998 order also added requirements regarding disclosure of exposures to market risk, in particular interest rates, equity and foreign exchange exposures. Securities law

Securities law is a third area of legislation that has affected financial reporting of banks.

The Securities Act 1978 was drafted as consumer protection legislation in response to some high profile investment scandals such as the 1976 failure of Securitibank, a private merchant bank (Hunt, 2001, p. 69). The banks are affected by this legislation because the term “security” as defined in the act ("Securities Act 1978"s 2D) also encompasses deposit products such as term investments. The act introduced the rules for offers of securities to the public, which includes the obligation to produce a prospectus and investment statement ("Securities Act 1978" Part II, s 33, 37). The specific requirements as to what has to appear in these offering documents, in particular also in respect of financial statements, are set out in the 1983 Securities Regulations ("Securities Regulation 1983"Schedule 1,2).

Collecting the financial data from annual reports and prospectuses in earlier years, one could observe that reporting requirements under the securities legislation did not always match the accounting standards used in the preparation of regular annual accounts at the time. This forced the banks to produce two sets of financial statements even though differences between the two methods were minute. Two examples of differences were alternative methods of accounting for the value of certain subsidiaries and the classification of debt instruments.

With the introduction of the bank disclosure statement requirement orders in 1996, registered banks became exempt from the requirement to produce prospectuses under securities legislation but up to this point in time, prospectuses were the only available source of financial information for some of the banks (e.g. Westpac NZ operating as a branch of its Australian parent).

While banks are no longer required to produce a prospectus – unless they were to list their equity on the NZX – the securities legislation remains the main foundation of reporting for non-bank financial institutions in New Zealand. As these rules are less specific than the non-bank disclosure regime, concerns regarding the disclosure quality of NBFI prospectuses has been expressed repeatedly (Securities Commission New Zealand, 2005; Van Schaardenburg, 2002) and might thus change in future.