The big question now: Could investors’ losses happen p all over again?
A financial services professional with more than 20 years’ experience in the industry says New Zealand has failed to address many of the issues which allowed Halifax NZ to fall over — and Kiwi investors are still at risk.
The professional, who declined to be named, said New Zealand regulations did not ringfence the risk within the country.
A spokesman for the Financial Markets Authority said holding client money offshore was not in breach of either the Financial Markets Conduct Act or FMA licence conditions, and licensed issuers had obligations to hold investor money in trust, no matter what country the funds are in.
“The FMA considers retail derivatives to be a high risk financial product and we’ve been clear that they may not be suitable for many retail consumers.
“Investors need to be aware of the risks and determine whether exposure to derivatives fits their risk profile, especially where the use of leverage exposes them to the risk of greater financial losses than the money they have ‘invested’.”
About 23,000 retail investors are reported to have accounts with licensed derivative operators in New Zealand.
An FMA risk assessment report on the sector, released in July following analysis of reporting by 24 derivative issuers, found some did not comply with the regulations for handling client money.
“Although DI [derivative issuers] view their controls for handling client money as very strong, we found instances of potential risks.
“Eight DIs also told us some or all client money and/or property is held offshore. These DIs may rely on the processes and controls of overseas entities to manage client money.”
The FMA notes in the report that it expects the issuers to have adequate and effective arrangements to receive, hold, use and disburse client money in compliance with regulations.
“Each year, licensed DIs must obtain assurance reports. Both of these reports must be completed by a qualified auditor and provided to the FMA.
“The assurance reports must also consider whether there are adequate safeguards against the loss, misappropriation and unauthorised use of client money.”
Halifax NZ had $1 million in capital put aside through a loan from its Australian parent.
The finance professional says that when the decision makers and core risk functions of these companies operating in New Zealand are offshore, it leaves clients exposed.
“When something goes wrong with the company outside New Zealand, there is very little that the FMA can do. This renders their regulations virtually pointless. It could easily have been a lot more costly if Halifax had a more global footprint.”
The FMA report found there was a risk that issuers were not taking reasonable steps to determine whether derivatives were suitable for their retail investors.
“Some survey responses indicate that DIs do not take into consideration a customer’s prior trading experience, understanding of leverage, or understanding of risk when assessing suitability.”
It also found retail customers may be getting poor results from margin trading and were getting themselves into debt.
“Some DIs also had a substantial proportion of retail investors with negative account balances, where the investor’s losses exceed their investment and they now owe money to the DI.”
When something goes wrong with the company outside New Zealand, there is very little that the FMA can do. This renders their regulations virtually pointless. It could easily have been a lot more costly if Halifax had a more global footprint.
The FMA said its future monitoring would address how issuers operated leverage — or borrowing — limits, including product suitability processes and controls to ensure clients understand the risks.
The FMA also found there was a risk that conflicts of interest were being poorly managed.
“Our survey revealed the majority of DIs operate a straight through processing (STP) model where all client transactions are fully hedged with a market counterparty.
“However, we were told about isolated instances of speculating against clients, such as DIs hedging less than 50 per cent of client trades or carrying a substantial level of unhedged positions. This presents a conflict of interest between the DI and their investors, as DIs can directly benefit from an investor’s losses.”
The FMA report said it believed the sector’s risk profile was high and it would continue to focus on monitoring.
“Our future monitoring of DIs will involve both desk-based and onsite inspections. Initially we will be following up with individual DIs to determine how they are addressing the risks identified . . .
“Where DIs are not meeting key compliance obligations, we may take action on the DI’s licence, or other enforcement action.”
But the professional investor said more needed to be done to protect the investor victims who were often people looking for ways to earn extra income as wages are stretched and low interest rates squeeze retirees.
Conflict of interest
“Effective regulations demand that regulators remove the conflict of interest between broker and client. Brokers must not in any way profit from client losses. Aligning the interests of client and broker is essential.”
And he says risk should be ringfenced within the country, reducing leverage and removing the moral hazard that exists between CFD providers and the client.
“An FMA licensed broker would then be the gold standard for retail clients. Until then, the public need to be aware that the FMA licence means very little.”
He says other countries such as the United States, Belgium and India have simply banned CFD derivatives being sold to retail investors.
“Like in Belgium, it may be necessary for our Minister of Commerce and Consumer Affairs, to step in.”
The FMA spokesman said it did not have the power to ban particular products.
“Some jurisdictions do have those powers and in certain circumstances have applied them to some types of retail derivative products, such as binary options.
“We have regulatory tools that we could use if we felt the need to intervene, such as the ability to alter licence conditions (i.e. in relation to leverage and margin), which we have done in the past.”
Finance industry veteran