Simon Papa calls for strategic, co-ordinated and ongoing action from the top of government down to resolve problems in the financial services sector

By Simon Papa*

On 20 August the Commerce Commission published its report containing recommendations to improve competition in the personal banking sector. Those recommendations are welcome but they only address some symptoms of a wider problem. In my view, the fundamental problem that afflicts New Zealand’s financial services sector is that New Zealand does not take financial services seriously as a key component of the economy. From the Government on down, we are at best indifferent to the sector. In some cases, we seem to have moral qualms about financial services.

The result is that there is no overarching strategy to guide the development and regulation of the sector for the benefit of New Zealand. That lack of strategy means that initiatives in relation to the sector tend to be reactionary and piecemeal, with resulting large inefficiencies, costly unintended consequences and missed opportunities. That’s even though financial services are a critical part of our economy, with the sector being equivalent in scale to the agriculture sector.

I think that we can only avoid similar outcomes in the future by implementing an overarching strategy for the sector, using the Commission’s report as a starting point.

Not having a strategy is not a strategy

The Commission’s report highlights the results of that lack of strategy, noting that “No single regulator or policy agency has overall responsibility for this sector”, that “there appears to be more fragmentation in New Zealand’s approach to financial services regulation than there is in other countries”, and that “unnecessary overlaps create inefficiencies and disproportionately impact small providers’ resources”.

In contrast, the governments of Singapore and the United Kingdom have effective strategies that have driven development of their financial services sectors. Arguably, those countries have more to gain since they have stronger financial services sectors. But it’s more likely that New Zealand’s regulatory fragmentation and poor outcomes are the result of an absence of strategy, not the cause.

New Zealand’s relatively small size and good governance are critical advantages that should enable New Zealand to act efficiently and nimbly to support economic development and service exports. Singapore is a standout example of how a small country can do that. Our failure to leverage that advantage in the financial services sector is a result of, in my view, a managerialist mindset on the key officials and regulators. The true potential of the sector can only be achieved by continuously seeking to identify, and to promptly action, opportunities.

Dead on arrival

While New Zealand is making some, much belated, progress towards better regulation of payment systems, there are numerous examples of missed opportunities and failure of imagination with respect to the financial services sector.

In 2009, then Prime Minister John Key tried to set in motion the development of a New Zealand managed fund sector servicing offshore customers. A working group's report supported the concept but officials and other politicians did not, so it did not proceed. There are examples around the world of this type of model being successful, including in Singapore and the United Kingdom. That a New Zealand Prime Minister could not get this initiative across the line highlights how difficult it is to make any significant changes in the sector.

For many years prior to 2020 the New Zealand Venture Investment Fund’s (now New Zealand Growth Capital Partners) $40m start-up fund prohibited investments in financial intermediaries. Such intermediaries are the very type of businesses that the Commission says need to be championed to help to increase competition in the banking sector. 

In August 2023 Parliament’s Finance and Expenditure Select Committee published a report into its inquiry into cryptocurrencies. Its recommendations were disjointed and mostly anodyne. The Committee said that “we recommend that the Government and regulatory agencies proceed carefully and do not design and implement a fully integrated and consistent regulatory framework for digital assets at this point in time. Instead, we recommend that problems are addressed as they arise.” The Government’s response was tepid. Singapore implemented a specific cryptocurrency licensing regime in 2020 and Australian is in the process of doing so. New Zealand is not even close to starting but we will certainly keep talking about the topic and keep our options open. To be fair to the Select Committee, it made a determined effort to step in and do something to address the vacuum of strategy and action.

Selling the silver

Mervyn King, a former Governor of the Bank of England, noted in his book The End of Alchemy: Money, Banking and the Future of the Global Economy that:

“Banks are also highly visible.… Even on the other side of the world, far from the epicentre of the financial crisis, the names of the tallest buildings you can see from Auckland Harbour in New Zealand are dominated by global financial institutions: HSBC, Citi, Rabobank, ANZ, Westpac, AIG, Zurich, PWC, Deloitte, Ernst & Young.”

Perhaps the biggest failure to think and act strategically in recent decades was allowing New Zealand’s systemically important banking sector to end up with about 90% foreign ownership. That level of foreign ownership most closely resembles that in ex-communist countries. That a government owned bank, Kiwibank, exists at all is almost entirely due to the efforts of the MP Jim Anderton in the early 2000s, not through any kind of clear-eyed Government strategy.

The four large Australian-owned banks are each amongst the largest businesses in New Zealand. Their combined annual revenues are about 3.5% of GDP. In its last full financial year ANZ made a profit of $2.3 billion. That profit is equivalent to total value of New Zealand's annual wine exports. So, New Zealand has to work very hard just to adjust for those profits, assuming they’re all repatriated.

In 2019 the Growing New Zealand’s Capital Markets 2029 report noted that the absence of primary listings of large banks on the NZX as an explanation for the NZX’s underperformance compared to its international peers. In Australia, five of the 10 largest listed companies are financial services businesses including the owners of the four large NZ banks. I have no doubt that New Zealand investors would have an appetite to invest in a large bank with a primary NZX listing.

Extensive foreign ownership of banks has other impacts. New Zealand misses out on the wider benefits of a larger stock market and the well-paid and relatively secure jobs that bank head offices based in New Zealand would generate.

Missed export opportunities

All governments have prioritised increasing service sector exports. However, financial services are not a priority. That's despite New Zealand having a wealth of financial services capability and expertise.

In the 2010s New Zealand became a popular place to develop derivatives businesses, primarily servicing clients in China. The drivers for operating from New Zealand appeared to include New Zealand’s good relations with China (including being the first OECD country to enter into a free trade agreement with China), the view that New Zealand is a safe and well governed country, and a large Chinese diaspora. Those businesses wound down in the 2020s, following a regulatory crackdown by the Chinese authorities, supported by the FMA in New Zealand.

Around the same time hundreds of New Zealand companies, owned and operated by people outside New Zealand, set up on New Zealand's Financial Service Providers Register (“FSPR”). They had no intention of providing services from New Zealand and many of those companies were involved in misconduct. That they could register in the first place was the result of policy makers not grasping how the world works in the internet age (resulting in three rewrites of the law’s territorial scope provision over 13 years). It didn’t help that, as one example, the Department of Internal Affairs allowed dozens of companies owned and managed off-shore to register on the FSPR on the basis they all had a “place of business” in New Zealand, being a Napier accountant’s office.

These examples are not the paradigm that New Zealand should be seeking to achieve. However, they highlight that New Zealand is an attractive place to do business, and that there is an opportunity to attract legitimate financial services businesses to set up and to export services from New Zealand. There are businesses that currently export financial services from New Zealand, and not just in the crypto sector. But they get little or no support or recognition.

My sense is that officials are simply not interested. They often justify doing nothing by rolling out the level playing field argument. That is, that New Zealand already has appropriate regulatory settings and that nothing more substantive needs to be done to support innovation and growth in the sector. The Commission’s report highlights that that is not the case.

A common, but amorphous, Sir Humphry tactic used by officials is to allege that just about any initiative involving international trade in the financial services sector may harm New Zealand’s international reputation. However, we manage to do lots of obviously unsavoury things in other sectors, like the increasing levels of pollution in waterways as a result of primary sector activity and implementing migrant worker schemes that are rife with abuse, with little apparent damage to New Zealand’s reputation. Financial services businesses support the creation of well-paid and permanent jobs, which isn’t always the case in other sectors, including agriculture and construction.

It will all reflect badly on me

A lack of strategy for the sector has allowed regulators to, at times, act passively and with apparent indifference to innovation, growth and competition.

Roger Hall's classic 1980s comedy Gliding On parodied inefficient government departments. The department’s boss in the show was seen scurrying to his office and crying out “it will all reflect badly on me”. I suspect that, in the case of the Reserve Bank, that mentality prevailed until quite recently. In 2017 the International Monetary Fund (“IMF”) noted that the Reserve Bank did not actively supervise banks, instead trusting banks to act appropriately. The IMF recommended that the Reserve Bank carry take a “more intensive approach to supervision” including actually visiting the banks it supervises. The Reserve Bank pushed back strongly. Only recently has the Bank moved to resource and prioritise enforcement.

The Commission’s report notes that the Reserve Bank’s capital settings are conservative, even by international standards. I think that this is due, at least in part, to the Bank’s history of non-active supervision. The result was even more conservative risk settings, to compensate for the risks arising from under-supervision. I suspect that high bank profitability is primarily viewed as a positive by the Reserve Bank, by further strengthening bank resilience.

The approach of the FMA, the other leg in the financial markets regulatory double, is different. The FMA has, since its inception in 2011, made a virtue of being close to the market and getting its hands dirty. However, in practice FMA has been selective in its efforts and has tended to focus on increasing oversight and regulation of the traditional financial services sector. FMA categorises other areas as being on its “regulatory perimeter” i.e. not part of its core business.

In October 2021 FMA appeared before the Select Committee considering cryptocurrencies. Despite noting its concerns about the risks presented by cryptocurrencies and linked scams, FMA did not provide any recommendations for how to address those risks. A somewhat incredulous Chloe Swarbrick kept pushing FMA to explain the dichotomy between concern and inaction. In response the FMA representative said that “we see the base question of cryptocurrency as somewhat outside of our field of expertise”.

That FMA had not developed expertise in cryptocurrencies, 10 years after they (and blockchain technology) emerged as the most significant innovations in the financial services sector in decades, was very disappointing. FMA has regulatory powers to act including through its ability to call financial products and services into the financial markets regulatory net. Sitting on the sidelines and wringing its hands in concern is not what FMA was set up to do.

Chaos by design

The lack of strategy has led to most regulator attention being focused on conduct regulation, some of it poorly designed and lacking net benefits. This increases costs (passed on to consumers), makes it hard for new entrants to enter the market (as highlighted in the report), and takes attention away from supporting innovation and growth.

The Commission’s report highlighted issues with NZ's AML/CFT regime. There are other issues with the regime not addressed in the report. One key issue in my view is that the AML/CFT law is poorly written and overly complex (there are eight separate sets of regulations). There are three frontline AML/CFT regulators (the Reserve Bank, FMA and the Department of Internal Affairs), with the Ministry of Justice and Police also closely involved. The frontline regulators are supposed to coordinate their activities including the guidance they issue. In practice coordination is poor and the guidance produced (consisting of a confetti of PDFs) is inadequate. There is no central registry of such guidance, which often appears without notice, even though supervised entities are required, by law, to take that guidance into account. Student projects often exhibit better attempts at co-ordination and clear expression.

The Commission's report noted the significant impact of the AML/CFT regime on FinTech businesses. In particular, the difficulty they have opening and maintaining bank accounts. Despite ongoing concerns about the disproportionate and unintended impact of the AML/CFT regime on various businesses and individuals, officials have made few efforts to address those concerns. The Commission recommends a form of AML/CFT licence for FinTechs to overcome barriers to obtaining bank accounts.

Lack of access to bank accounts is not just an issue of obtaining basic banking services. The fundamental issue faced by many FinTechs is that they need client money bank accounts (where funds are held on trust for customers) to provide their services. While in some cases banks will open basic business bank accounts for FinTechs, they very rarely permit FinTechs to open client money accounts.  

The issues with bank accounts for FinTechs cannot, in my view, be addressed by fixes to the AML/CFT regime. The bigger issue is that New Zealand does not have licence classes for key financial services provided by FinTechs, including remittance services, exchange services, client money services, and crypto-related services. There seems to be an unspoken belief amongst officials and regulators that this light touch approach facilitates the provision of new services. The opposite is often true. The absence of licence options is a significant impediment to developing the level of credibility required to open bank accounts, to gain credibility with other counterparties in New Zealand and overseas, and to attract customers. Singapore shows how new licensing regimes can both improve consumer protection and encourage legitimate innovation and growth in the sector.

A new paradigm

In 2017 I argued that New Zealand needed a FinTech strategy (and a wider financial services strategy), to help to ensure that New Zealand reaps the benefits from a thriving FinTech sector. That sector has the potential to resolve some of the structural issues that have developed over several decades. Useful initiatives are being undertaken, including the proposed open banking law, and steps to regulate and open up aspects of the payments network. But those initiatives have developed painfully slowly. We are very well behind international peers in these areas.

There is incredible energy and capability in the FinTech sector, and the wider financial services sector, but they are not being supported nearly enough. I believe that we will only resolve the issues in the financial services sector and its regulation through strategic, co-ordinated and ongoing action from the top of Government on down. The Commission’s report is a good starting point. But the report is not the solution to the wider problem that prevents New Zealand’s financial services sector from achieving its true potential.

*Simon Papa is a commercial lawyer with 20 years experience and director of Cygnus Law. Cygnus Law is a boutique law firm that specialises in advising businesses in the financial services sector.