ASIC drags non-banks back to reality
The regulator's proposed reforms for non-bank lenders are a well-balanced mix of arms-length and incentive-based measures which should bring some stability to the troubled sector.
The range of potential responses by regulators to collapse like Banksia, or Storm Financial, Westpoint and a number of other similar implosions, starts with quite intense prudential regulation and ends with nothing much more than ‘’investor beware’’ stickers all over their fund raising documents and shop windows.
The risk with a too-heavy handed response involving intensive prudential controls and regulatory oversight is moral hazard and promoter and investor complacency. It raises, as the Pyramid collapse did more than two decades ago, the prospect of reckless behaviour and taxpayer exposures.
Light-handed or minimal regulation and a ‘’caveat emptor’’ approach leaves retail investors exposed to white-shod spruikers and governments and their regulatory agencies both embarrassed and under pressure to alleviate the losses and hardship of burned investors.
ASIC has issued a consultation paper on its proposed reforms to regulation of the debenture sector. Currently the regime is disclosure-based, albeit supplemented (after the controversies of earlier collapses) by more intense (but self-evidently, in the Banksia case, less-than-successful) surveillance by ASIC.
The starting point is that non-bank issuers should be more clearly distinguished from the authorised deposit-taking institutions (ADIs) that operate within the Australian Prudential Regulation Authority’s jurisdiction and prudential framework.
That’s a regime that involves very intense and active regulation and sophisticated and expensive prudential requirements, including quite prescriptive and onerous levels of capital adequacy and liquidity.
As ASIC says, it is necessary to signal clearly to investors that debentures carry higher risks than deposits with ADIs. (Although the investors themselves, one would have thought, would question why they are getting returns significantly higher than those available from deposits if not for a materially higher risk of losing some or all of their money. The history of the sector says there are lot of unquestioning and/or greedy investors out there).
In the wake of the Banksia collapse – it went down owing $660 million, with investors likely to lose between 35 per cent and 50 per cent of their money – it was never going to be sufficient for ASIC to simply beef up the disclosure requirements for those issuing debentures to retail investors, although there will be some extra disclosures to investors rolling over investments or adding to existing holdings.
So ASIC proposes to put in place a skeleton version of APRA’s prudential regime, introducing minimum capital and liquidity requirements for debenture issuers, with a minimum capital ratio of 8 per cent of total risk-weighted assets and minimum liquidity holdings of 9 per cent of their liabilities. If the issuer were involved in property development it would carry a minimum capital ratio of 20 per cent.
Instead of ASIC itself directly policing those requirements it would beef up the roles of trustees and auditors, charging the trustees with supervising compliance and imposing explicit obligations on them to exercise diligence. Issuers would be obliged to notify the trustee and ASIC if they didn’t meet the capital and liquidity rules – and stop raising funds from retail investors.
Auditors would be required to report biannually to the trustee and include any matters that could be prejudicial to the interests of the debenture holders.
The point of the capital and liquidity requirements isn’t to create any guarantees against failure, although it would ensure the entities were better capitalised and had the funds to withstand small shocks to their balance sheet. It would also help reduce the risk of complete and instant implosion and disorderly liquidation if a business did still fail.
The more significant implication of requiring capital buffers is that the capital would have to come from the promoters or, at least, larger professional investors who would then, in ASIC’s terms, have "skin in the game". The prospect of losing real money of their own would presumably make them less inclined to be reckless with retail investor funds.
The proposed reforms would, of course, raise the costs and barriers to entry within the non-bank financial sector and reduce competitive intensity and, perhaps, innovation within the system. The continuing collapses of non-bank lenders, of course, would have much the same effect at a greater, or at least more painful, cost to investors.
By keeping itself at a reasonable arms-length (and APRA completely out of the picture) and relying on reasonable simple prudential tools backed up by the stronger roles for trustees and auditors, ASIC will probably avoid injecting more moral hazard into the non-bank segment of the system and retain some of the onus on investors to recognise they are being paid a risk premium for taking more risk.
Raising the barriers to entry and reducing the competitiveness of the debenture-issuers against APRA-regulated institutions also appears a reasonable trade-off between the impacts on competition and innovation and somewhat stronger investor protection, particularly as the proposed regime is targeted essentially at entities tapping retail funds.
Banksia and others looked like, and to some extent presented themselves, as just another version of an ADI. If entities raising funds from the public are regarded as similar, if not the same, as regulated institutions and perform similar, albeit not identical functions, then they probably should attract some measure of regulation and additional scrutiny even if there are some associated costs.