3 March 2009

Luncheon Address to ASIC Summer School, Sydney


'Impact of the Global Financial Crisis on the  Corporations and Financial Services Regime'


Thank you Tony for that introduction.

First, welcome to everyone here today, representatives from regulators across the world and from here at home. Welcome also to the delegates, and I understand from Tony that there are in excess of 400 of you in attendance.

The ASIC Summer School - this year themed very rightly around the Global Crisis: The big Issues for our financial market - is a major contribution to the strength and vibrancy of the national debate on finance and corporate issues.

And this year, perhaps more than ever before, the themes under discussion sit at the core of a national and global debate around the causes, the implications and the remedies of what has become known as the "global financial crisis".

Today I am going to make some comments on the impact of the global crisis on our corporate and financial services regime here in Australia. But before I do I want to say a few words about what might be called the "new" ASIC.

ASIC's readiness

The last year has been one of significant reform and change at our national corporate regulator.

Overall, the strength of our corporate regulatory environment has been commented on around the world.

One recent example is from the Group of 30 Consultative Group on International Economic and Monetary Affairs, who, through its Chair, Mr Paul Volcker, the former U.S. Federal Reserve Chairman, singled out Australia, along with only the Netherlands, as closest to "optimal" regulation across 17 key jurisdictions.

The United States Treasury has also pointed to our current model as the preferred form.

Yet, despite these strengths, the Commission and the Government have been working to make ASIC even stronger, a strategy that I am confident will bear fruit as the global recession unfolds during 2009.

Chairman D'Aloisio has seen through a major internal structural review that has witnessed the organisation move significantly closer to the markets and participants it regulates.

ASIC has also taken on a major new feature of our regulatory system in the form of a uniform national credit law.

In addition, the Rudd Government has delivered almost $100 million in new funding and doubled the size of the Commission from three to six.

I would like to take this opportunity to publicly welcome the full Commission of Chairman D'Aloisio, Deputy Chairman Cooper, and Commissioners Gibson, Boxall, Medcraft and Dwyer.

I do believe that you are ready for the year ahead.

The path to 2009

I will shortly set out what actions and reforms the Rudd Government has taken, is taking and will take in response to the global recession, but before I do I would like to take this opportunity to make some broader comments on the path that led us to where we stand in early 2009.

The globalisation of modern finance - its rapid strides forward, its scale, complexity and its pervasiveness - is a phenomenon that will undoubtedly form the basis of decades of analysis.

A figure that illustrates the magnitude of this expansion comes from the McKinsey Global Institute which found that the ratio of global financial assets to global output jumped from 109% in 1980 to 316% in 2005.

And what drove these orders of magnitude of growth?

The drivers are complex and global and those that were here yesterday would have heard the Deputy Secretary of the OECD run through these issues.

These drivers include staggering levels of global macro-level imbalances - with China, Japan and others recording very high current account surpluses, and the U.S. and the U.K., among others, recording correspondingly significant current account deficits.

These imbalances grew to mark out a central disparity in the global financial system.

Massive currency reserves in the surplus states sought low-risk Government bonds in which to invest. This then pushed down real interest rates, which opened up access to credit to a vast new group of participants in developed countries.

Anytime a ripple was felt in this arrangement the U.S. Federal Reserve would cut the Federal funds rate to boost liquidity into the market and retain buoyancy.

As a result, household debt levels exploded and the breadth of borrowers pushed boundaries never before seen. The so-called "sub-prime" borrowing sector was suddenly on the radar, particularly in the suburbs of American cities.

But the real driver, the real mechanism through with the entire global system was infected, are the products of what has been called financialisation or financial "innovation".

The development of highly sophisticated, complex, fluid and often derivative-based products that packaged debt - debt which was often highly toxic, although frequently very well rated by the credit rating agencies - and allowed it to be diffused throughout the world.

According to the Bank of International Settlements, the notional global value of these derivatives reached a truly staggering US$531 trillion by 2008.

In lock-step, the finance sector grew massively as a portion of GNP in the U.S. and the U.K. in particular, but also here in Australia.

I would turn to a line from my friend Lord Adair Turner, the recently appointed Chairman of the U.K. Financial Services Authority:

"Not all innovation is equally useful. If by some terrible accident the world lost the knowledge required to manufacture one of our major drugs or vaccines, human welfare would be seriously harmed. If the instructions for creating a collateralised debt obligation squared have now been mislaid, we will, I think, get along quite well without".

On this I think Lord Turner is correct.

This is not to say that the intermediation markets of the private equity funds, the hedge funds or mortgage brokers are destined only to the rubbish heap of history.

It's also not to say that the securitisation of the "originate-and-distribute" model, or its associated acronym cluster of CDO's, CDS's, RMBS's, CMBS's is intrinsically dangerous - although I do recall a time when we were told to be scared of ICBM's, the intercontinental ballistic missile.

We have clearly moved on - nowadays the ICBM has been overtaken by the RMBS. I'm not sure anymore which we should be more worried about!

Rather, my key message is to say that the through ripping asunder of the relationship between borrower and lender, the separation of risk from responsibility, the widening of the gap between ratings assessors from end users, the free-for-all approach to financing and debt - are all structural features of the last decade that have absolutely no role in the future of Australia's, or the world's economy.

And where does that global economy sit as of early 2009.

We are all well aware that the world is in dire financial straits - we are in fact heading into a global recession with global growth forecasts slashed for this year. Globally, growth is expected to fall to the lowest level since World War II.

Fiscally, the international picture is also dire with the IMF now forecasting a collective budget deficit of seven per cent of GDP for advanced economies.

Australia obviously cannot be immune from the effects of this crisis.

A budget deficit is now forecast for 2008-09 of $22.5 billion, or 1.9 per cent of GDP.

Comparatively, this is markedly better than any of our peer economies and as a member of the Rudd Government I can again reaffirm our commitment to deliver budget surpluses, on average, over the course of the economic cycle.

As the economy recovers, and grows above trend, the Government will take action to return the budget to surplus.

Response to the crisis

Nation Building and Jobs Plan

Before going to a range of corporate legal reforms driven in the main by the global crisis, I want to mention the broad and decisive action the Rudd Government has taken to date at the macro-level.

In the midst of this global recession it would be irresponsible not to act swiftly and decisively to support jobs and invest in nation building.

That's why, on 13 February, the Australian Parliament passed the Rudd Government's $42 billion Nation Building and Jobs Plan to support jobs and to invest in future long-term economic growth.

Stimulus packages are a sound strategy. 

Treasury estimates that the Nation Building and Jobs Plan will support up to 90,000 jobs in 2008-09 and 2009-10. The initiatives in the Plan will boost economic growth by about ½ per cent of GDP in 2008-09, and around ¾ per cent to one per cent of GDP in 2009-10.

The $42 billion Nation Building and Jobs Plan builds on the stimulus measures already implemented by the Rudd Government to support economic activity and jobs, including the $11 billion Economic Security Strategy.

With so much at stake, this is clearly no time for indecisiveness or delays. In fact, the IMF recently urged governments around the world to implement their stimulus packages quickly.

And that's exactly what this Government is doing. 

We are rolling up our sleeves, and getting on with the job of supporting households and businesses — and above all, supporting jobs.

And I can assure you that the Government will continue to take whatever steps are necessary to support growth and jobs during these testing times.

Australia as part of the global solution

The financial innovation I mentioned earlier - the real-time conduits of global finance, instantly transmitting products around the world - has been shown to sit at the very heart of the global crisis.

Whether it was the virus or simply the transmission system has been hotly debated here both yesterday and today.

But one thing is certain, this financial innovation has highlighted the very real cracks in the regulation of the world's financial systems.

Regulatory arrangements have frequently failed to keep pace with the globalisation of financial activity and we have seen a failure of internal governance within financial institutions, and a failure of external oversight to recognise and respond to risks.

Again compared with other economies, Australia's regulatory system has stood up well to global market turbulence.

But we must always be aware that, as a member of the global economy, we also need to be part of the global solution.

Prime Minister Rudd advanced that agenda in his address to the United Nations General Assembly in New York on 25 September last year, where he set out a five‑point program to address problems the exposed by the financial crisis.

First, systemically important financial institutions should be licensed to operate in major economies only under the condition that they make full disclosure and analysis of balance sheet and off‑balance sheet exposures.

Second, we need to ensure that banks and other financial institutions build up capital in good times as a buffer for the bad times, using predictable rules.

Third, financial institutions need to have clear incentives which promote responsible behaviour, rather than unrestrained greed. 

Fourth, supervisory systems must be compatible with accounting principles that reflect reasonable assessments of the value of assets over time. 

And lastly, the IMF should be given a strengthened mandate for prudential analysis.

All of these issues were addressed in the Washington Declaration from the G20 Leaders' Summit held in November 2008, which incorporated these reforms into a comprehensive 47-point Action Plan which covers improved financial regulation, and seeks better international cooperation and reform of institutions such as the IMF and World Bank.

Implementation of the Action Plan will create an improved global regulatory system, one that will react differently during the next boom and help firms and regulators to better manage risk.

We can expect delivery of the Action Plan to result in improvements to prudential oversight, regulatory regimes, compensation schemes and risk management practices and valuation and transparency.

Meetings such as those held on the sidelines of the Summer School, such as those I have had with SEC Commissioner Kathleen Casey and IOSCO Secretary General Greg Tanzer continue the momentum.

The Prime Minister's meeting with President Obama on March 24 and the second Leaders' Summit on 2 April will be the next critical steps down this pathway for global cooperative reform.

But here in Australia we are also seeking to lead the way with clear, decisive and effecting regulatory responses and in doing so are achieving solid progress on addressing the regulatory reform proposals set out in the Action Plan. 

For us it is more an exercise in fine-tuning our corporations and financial services regime rather than the wholesale renovation clearly needed elsewhere.

The financial crisis has brought these issues into stark relief - many of which have been languishing in need of action for a decade.

Time will only allow me to touch on a sample of these areas, but I want to make some comments on credit rating agencies, short selling, national credit regulation, including margin lending and finally executive remuneration.

Credit rating agencies

We all in this room have a fair understanding of the critique of the role of credit ratings agencies in the global financial crisis, so I won't today repeat the facts.

Needless to say that their involvement in providing inaccurate ratings of structured financial products in the lead-up to the US sub-prime crisis has prompted a universal consensus for their improved regulation.

I have been in dialogue with former Chairman Cox at the SEC and Commissioner McCreevy at the European Commission, among other regulators.

As part of this global response, I undertook a review of ratings agencies, and research houses, here in Australia. I assessed the situation and on the back of this, the Rudd Government and ASIC are taking decisive action to upgrade the supervision of credit rating agencies to promote and maintain confidence in our financial system.

Rating agencies must now have an Australian Financial Services Licence to operate in Australia - the AFSL system is sufficiently flexible to accommodate the product that ratings agencies generate and from July 1 all ratings agencies must be licensed.

Ratings agencies will also be required to issue an Annual Compliance Report based on how they have conformed with the recently updated IOSCO Code of Conduct Fundamentals for Credit Rating Agencies. Critically, this includes conflicts of interest management.

It is completely unacceptable to have such a systemically important set of entities as ratings agencies operating in Australia but sitting entirely outside our regulatory system.

By linking their compliance reporting to the international standard this will automatically ensure our regulatory response is in line with the global consensus.

We are also calling on the private sector to do more - this week I am convening two roundtables, one with the major banks and another with key finance industry groups, to further improve the overall ratings process, this time from the perspective of the role of the users of ratings.

The roundtables will discuss ways of improving due diligence of ratings, and improve the quality of information underpinning ratings.

These roundtables will be a catalyst for constructive action that the private sector can take in combating one of the underlying causes of the global financial crisis. 

I look forward to informing you of the progress initiated by the roundtables in due course.

Short selling

I don't plan to make extensive commentary today on short selling. I am sure you all read the business pages where it sometimes seems hard to find a story on anything else.

As I have previously said, if you had asked any social commentator to list the great public issues that may have been in with a chance of knocking real estate off the top of the barbeque-stopper list, I don't think many - probably any - would have gone for short selling.

But what a year it has been.

As you would be aware, in September last year, ASIC and the ASX implemented a total ban on covered and naked short selling, respectively. This decision aligned with the actions of securities regulators around the world to limit the activity of short sellers. The measures were designed to restore market confidence during a period of unprecedented and volatile economic conditions. 

As part of a staged and measured approach to the re-opening of covered short sales, ASIC lifted its ban on the short selling of non-financial stocks from 19 November 2008.

However, given the systemic importance of financial institutions to the Australian economy and questions surrounding the ongoing rumortrage targeting of Australian financial institutions, ASIC recently decided to further extend its ban on short selling of financial stocks until 6 March this year. 

The Government welcomed this decision as one made in the national interest rather than in the interests of any particular group of market participants.

This decision complements other Government initiatives such as the bank deposit guarantee that have been needed to ensure the ongoing stability of Australia's financial sector. 

To further ensure the integrity and transparency of our markets in December last year, the Government passed the Corporations Amendment (Short Selling) Act 2008

The detailed Regulations are shortly to come - there will be hard decisions to be made on the time of reporting, net versus gross, and a number of other matters - but rest assured the Government will again make these decisions with an eye on the global work underway through IOSCO.

The regime will reflect the best interests of the market and in doing so will be firmly in the national interest.

Once the regulations are in place, the ASIC interim disclosure regime introduced last year can be withdrawn. 

The Act has been critisized as "hollow", I would strongly question the critics' understanding of what the Act achieves - outlawing naked short selling, significantly boosting ASIC's powers to regulate short selling, providing certainty to the market and putting in place a world's best-practice disclosure framework.

This action does not sound particularly hollow to me.

I would also take this opportunity to note that we are very aware of a range of short selling-like instruments that some participants are seeking to employ to have the effect of a traditional short sale.

I would counsel those involved that both the Government and ASIC are watching these developments very closely.

The range of actions on short selling are another example this Government analysing a key corporate law issue, finding a gap in the regulation and immediately taking appropriate action to fix it.

National regulation of consumer credit

One of the more far-reaching ways the Government is reforming our financial services regulatory regime is by developing one single, standard, national system to regulate all consumer credit and the remaining financial services that sit with the States and Territories.

The Commonwealth took a National Action Plan to COAG to transfer all consumer credit products to the Commonwealth. As you would all be aware, COAG agreed to this landmark decision on 2 October 2008. 

This important initiative by the Rudd Government will address the deficiencies that have long existed in credit regulation by establishing a consistent and robust consumer credit regulation framework. 

To make the transition as smooth as possible, we are implementing national credit regulation in two phases. 

This phased approach strengthens consumer protection, while minimising disruption to business.

Under the first phase of the plan, the Commonwealth is taking responsibility for the existing State and Territory legislation — the Uniform Consumer Credit Code — by enacting it as Federal law. Work on this phase is well underway for an introduction into Parliament by the middle of this year. 

As I have stated previously, the new national consumer credit law will establish, for the first time, a comprehensive national licensing regime to be administered by ASIC. This will cover all credit providers, including margin lending providers, as well as brokers and advisers.

ASIC will be given extra powers as the sole regulator to enforce the regime.

The new national law will emphasise general conduct obligations which will require the provision of credit services honestly, fairly and responsibly. 

Specific responsible lending requirements will also be in place to protect consumers from being given loans they cannot afford to repay. 

Important safeguards will also be built into the national scheme.  All borrowers will be able to appeal to an external dispute resolution body to which all licensees must belong.

I would take this opportunity to note very specifically that the regulation of margin lending will be greatly improved - it will become a Chapter 7 financial product, its disclosure will be clear, succinct and contain information on commissions. It will also have its own tailored responsible lending obligations, including a requirement for the ultimate lender to know whether the capital being brought to the table by the retail borrower is in fact their own, or whether it is itself debt, such as equity from a home. In such cases the lender will be required to assess what I call the "true loan to value ratio".

These reforms are a decade overdue and are the right response at the right time - the free-for-all of the last decade that has seen so many mums and dads, even grandmothers and grandfathers, ruined will not continue.

The second phase of the action plan will look at possible further rules to stem unfavourable lending practices, such as a review of credit card limit extension offers and deceptive advertising practices and other fringe lending issues.

Ladies and gentlemen, this is a major step forward - whilst our colleague in the United States grapple with a plethora of jurisdictional turf wars, whilst the Canadians continue to regulate financial services at the provincial level and whilst the European Union seeks to harmonise often widely varying laws between Member States, Australia will move to a seamless, national approach.

It means that we will have the kind of truly national system we need. 

This will cover all consumer credit and financial services, and will help to ensure that the Australian credit market remains active and competitive — both domestically and internationally.

It is a necessary renovation and modernisation for the 21st century.

Executive remuneration

Before closing today, I want to make mention of the issue of executive remuneration.

There has been a lot said in the community, the press, by politicians and indeed here at the Summer School on this issue.

It was commented at last night's dinner that the average person on the street is much more likely to have a view on executive remuneration than on the regulation of derivatives.

That is certainly a statement of truth.

But there is a reason for that - the hard working people of Australia have a fair amount to be angry about.

Many - of course not all - executives are paid exorbitantly.

Thankfully, we do not commonly see the hundred million dollar examples you see in the United States.

However, in Australia we do unfortunately see examples of pay excess.

One key change over the past 20 years has been the spread of share ownership both direct retail and indirect through compulsory superannuation. There is a far deeper and broader ownership stake in our economy by the broader community, and with that ownership comes interest.

The Rudd Government has already taken action.

At the direct request of the Prime Minister, APRA is developing a set of guidelines that relate to how executive remuneration and risk-taking interact with prudential capital regulation in the financial sector.

This is critically important work and directly related to the causes of the global financial crisis, how it spread throughout the world financial and economic systems, and perhaps most importantly, it relates to how it can be avoided in the future.

On non-financial executive pay, my colleagues and I have indicated that the Government has all workable options on the table, and that remains the case.

By workable we mean options that will actually deliver results, not false hopes or headlines.


Ladies and gentlemen, there are a range of other initiatives underway, from my referral to the Corporations and Markets Advisory Committee of critical issues of market integrity, rumourtrage, blackout trading and analysts' briefings, to reform ofthe corporate law as it relates to unsolicited share offers.

I referred earlier to the Prime Minister's address to the United Nations in September last year. I would like to close by restating the words of Mr Rudd on that occasion:

"The stability of global financial markets is a public good.

If Governments fail to protect this public good, then those who suffer are the working people of the world whose jobs, whose homes, and whose standard of living depends on it.

It is Governments rather than speculators that have the central responsibility for determining the rules that govern the way markets work."

As you can see from my words this afternoon, the Australian Government takes this mandate very seriously.

I trust I can rely on your ongoing professionalism, advocacy and support as we go forward.

Thank you, and I hope you enjoy the rest of the Summer School.