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Report Preface

The Australian Securities and Investments Commission was pleased to host the ASIC Summer School 2009 in Sydney from 2–3 March 2009. This was our 14th successive Summer School.

This year’s theme was ‘Global crisis: The big issues for our financial markets’. We brought together experienced practitioners from the Australian and international communities to provide in-depth analysis and challenge current thinking about the global financial crisis: what went wrong, what we’ve learned, and what’s next for markets and regulation in the international financial economy.

The event was held at a time of highly volatile financial conditions and a persisting lack of confidence in global markets. Over the course of two days, the Summer School sought to unravel the headline features of the current global financial crisis including:

the underlying causes the spread and speed of contagion the scale and commonality of efforts by governments to restore confidence in the global financial system and markets, and

the need for policy makers and regulators to develop a blueprint for regulatory reform of securities and investment markets.

Participants in the ASIC Summer School had the opportunity to confront the challenges and debate the pressing issues. Plenary and panel sessions featured presentations and commentary from corporate directors and CEOs, from Australian and international regulators, and from an international economist. Participants also met and talked with members of the new ASIC leadership team, recently appointed after an extensive strategic review of our priorities and structure.

This report is a record of presentations and panel discussions from the plenary and associated panel sessions. It also includes PowerPoint presentations and information about where to access papers referred to during speeches, if available.

Thank you to everyone who contributed to the success of this year’s Summer School. I hope you find this report useful.

Tony D’Aloisio Chairman, ASIC Contents

MONDAY 2 March 2009 5 The crisis: causes, consequences and lessons for the future. The international perspective Dr Adrian Blundell-Wignall, Deputy Director, Financial and Enterprise Affairs, Organisation for Economic Co-operation and Development

Panel discussion moderated by Mr Jeremy Cooper, Deputy Chairman, ASIC Mr Chum Darvall, Chief Executive Officer, Deutsche Bank, Australia/New Zealand Mr Robert Elstone, Managing Director and Chief Executive Officer, Australian Securities Exchange Limited Mr Stephen Roberts, Citi Country Officer and Chief Executive Officer, Institutional Clients Group Australia/New Zealand, Citi Australia Mr Michael Smith, Chief Executive Officer and Director, Australia and New Zealand Banking Group Limited

41 The crisis: causes, consequences and lessons for the future. The Australian perspective Mr Ian Macfarlane AC, former Governor of the Reserve Bank of Australia, and Director, Woolworths Ltd, ANZ Banking Group Ltd and Leightons Holdings Ltd

Panel discussion moderated by Mr Tony D’Aloisio, Chairman, ASIC Mr Ric Battellino, Deputy Governor, Reserve Bank of Australia Ms Belinda Gibson, Commissioner, ASIC Dr David Gruen, Executive Director, Macroeconomic Group, The Treasury Dr John Laker AO, Chairman, Australian Prudential Regulation Authority Mr Graeme Samuel AO, Chairman, Australian Competition and Consumer Commission

59 What went wrong: lessons from the boardroom Dr John Stuckey, Senior Advisor, McKinsey & Company, and Chair, ASIC External Advisory Panel

Panel discussion moderated by Mr Peter Thompson, ABC television and radio broadcaster Mr David Hoare, Chairman, Principal Global Investors (Australia) Ltd Ms Belinda Hutchinson AM, Non-Executive Director, QBE Insurance Group Ltd Ms Catherine Livingstone AO, Non-Executive Director, Telstra Corporation Ltd and Macquarie Bank Ltd Mr David Murray AO, Chairman, Future Fund

TUESDAY 3 March 2009 84 Global markets, global solutions: the new global financial architecture Ms Kathleen Casey, Commissioner, US Securities and Exchange Commission Mr Hector Sants, Chief Executive Officer, Financial Services Authority, UK (pre-recorded interview by Ms Emma Alberici, ABC Europe Correspondent)

Panel discussion moderated by Mr Tony D’Aloisio, Chairman, ASIC Ms Zarinah Anwar, Chairman, Securities Commission, Malaysia Mr Greg Tanzer, Secretary General, International Organization of Securities Commissions Mr Martin Wheatley, Chief Executive Officer, Securities and Futures Commission, HK

Special guest speaker: Senator the Hon Nick Sherry, Minister for Superannuation and Corporate Law, speech available at www. minscl.treasurer.gov.au

112 Hedge funds: friends or foes? Mr Kim Ivey, Chairman, Alternative Investment Management Association (AIMA) Australia, and Managing Director, Vertex Capital Management Ltd

Panel discussion moderated by Dr Peter Boxall AO, Commissioner, ASIC Mr David Hartley, Chief Investment Officer, Sunsuper Pty Ltd Mr Gary Simon, Head of Investments Group, Global Markets, ABN AMRO Australia Ltd

132 Structured products: how will we deal with them in the new financial markets? Mr Greg Medcraft, Commissioner, ASIC (previously, Executive Director and Chief Executive Officer, Australian Securitisation Forum, Global Head, Securitisation at the Société Générale)

Panel discussion moderated by Mr Michael Dwyer, Commissioner, ASIC Mr Robert Camilleri, Senior Manager, Credit, Aviva Investors Australia Ltd Mr Ben McCarthy, Managing Director, Fitch Ratings Australia Pty Ltd Mr Gary Sly, Director, Debt Capital Markets, Global Markets, ANZ Banking Group Ltd Mr Andrew Twyford, General Manager, Treasury and Securitisation, Challenger Financial Services Group Ltd

152 ASIC priorities: a panel discussion with ASIC’s Commissioners

PROFILES ASIC Commission Speakers, panellists and moderator 4 Australian Securities and Investments Commission | ASIC Summer School 2009

MONDAY What went wrong and what we’ve learned Opening and welcome address

Mr Tony D’Aloisio, Chairman, ASIC

What is this year’s ASIC Summer School We will be looking at financial reporting, program about? Well, of course we all know rumourtrage, short selling, superannuation, that we’re in the midst of the most serious counterparty risks, auditors, credit rating global financial market crisis since the Great agencies, and retail investors. Depression. We all know that restoring confidence in financial markets is going to be Tomorrow afternoon, we get even more the key for economic recovery. specific and look at what ASIC is doing. ASIC’s leaders will present an outline of what Our program this year is very much focused they’re doing in their areas, and the on the financial markets. This morning, we moderators for those sessions will be will focus on what went wrong and what industry leaders who will ask them some we’ve learned—an international perspective questions. and then an Australian perspective. At this evening’s dinner, we will look at lessons from Tomorrow afternoon, before we close, you the Boardroom. Tomorrow morning’s session will get an opportunity to question the full will look at the future. We ask the questions: Commission and ask us about our priorities A new financial order? If there needs to be and our objectives. change, what should those changes be? So, in summary, it’s a program that we feel is Our hope and expectation is that the well-designed to traverse both big picture Summer School will contribute important and day-to-day issues, particularly issues insights into what’s happened—not to blame, confronting all of us over the next 12–24 but to learn and consider a possible road months. I welcome you to the Summer map for future reform, reform that needs to School. Thank you for attending. We do hope work to instil confidence in reopening you have a most enjoyable conference. financial markets. Please join with me in welcoming our Deputy We have two sets of workshops—this Chairman, Jeremy Cooper, who will get us afternoon and tomorrow afternoon. This straight down to business into the first afternoon’s workshops are about getting session this morning. Thank you. down to the specifics, to look at issues that have arisen and to see how they’ve been handled. The crisis: causes, consequences and lessons for the future. The international perspective 5

MONDAY What went wrong and what we’ve learned The crisis: causes, consequences and lessons for the future. The international perspective

Dr Adrian Blundell-Wignall, Deputy Director, Financial and Enterprise Affairs, Organisation for Economic Co-operation and Development

Opening remarks by Mr Jeremy Cooper, Deputy Chairman, ASIC

For the accompanying PowerPoint presentation, see page 34.

JEREMY COOPER ADRIAN BLUNDELL-WIGNALL The topic this morning looks at the global Thank you very much. In terms of the financial crisis—the causes, consequences subprime crisis, I’ve been writing about this and lessons for the future—focusing extensively enough for a couple of years and, specifically on the international perspective. in terms of the global financial crisis, there After morning tea, we will focus on the are a fair few things I want to cover. Some of Australian perspective. this is drawing on my own work; some of the later slides are drawing on work that we’re I will make just make a few comments and doing at the moment in the OECD frame the very interesting session that’s (Organisation for Economic Co-operation and coming by reading a quote: ‘In all my Development) as a contribution to the G20 experience I’ve never been in any accident of and to our ministerial out towards June. any sort worth speaking about. I’ve seen but one vessel in distress in all my years at sea. I think the way to think about the problem of I never saw a wreck and never have been the subprime crisis is as a principal–agent wrecked, nor was I ever in any predicament problem. The principals—taxpayers, that threatened to end in disaster of any sort.’ shareholders, bond holders and so on—are being very badly let down by their agents— Now, that quote was from the captain of the the regulators, supervisors, central banks in Titanic some few years before the fateful some cases (not here in Australia I hasten to disaster that we all know about. He was add), treasuries, CEOs, Boards and so on. speaking of 40 years’ experience as a seaman then as a captain, so it leads me to The global macro background has been the wonder in relation to the global financial big factor. And in micro, the thing I’d probably crisis: were the causes obvious, or were they say is that, in the changes in banking and all black swan events much like the Titanic was the competition between regions, there was a to Captain Smith? change in the model of banking going from ‘kicking tyres’—the old model of what I call Our speaker and a panel of experts are here the ‘credit culture’ in banking—to mixing an today to answer these questions. ‘equity culture’ with that credit culture. A lot of the things and the incentives that came out of that mixing of the equity and the credit 6 Australian Securities and Investments Commission | ASIC Summer School 2009

culture go to the heart of these principal– and other assets, they gave it to mortgages, agent problems. and so that created an asset allocation distortion. And, of course, we had through My second slide sets out some background the 1990s into the late 1990s and, finally in forces I want people to remember when 1999, removal of Glass-Steagall.1 Prior to thinking about causes. It’s very hard to work that, we had some rule removals in the US out causes in this story, but when economists Federal Reserve Bank, which removed all think about causes they tend to think about semblance of the firewalls that there were things that have a bit of exogeneity to them. between things—and I’ll come back to this So, something relatively exogenous point because it is actually very important in happens, which causes something relatively my view. endogenous to happen as a consequence. Then, of course, there is the whole Basel I think that’s really quite an important thing to process, although with John Laker in the keep in the back of your mind here, because audience I fear to go into this topic. We have there were many, many things going on over already clashed and discussed this issue ad many, many years that basically led to nauseam. increased debt versus equity throughout the system. And, of course, I start off with the When we’re talking about causality, all those global liquidity situation, which caused global background factors are there and they’re excess liquidity to emerge as one of the key important. To get an analogy going—in case background factors. The subprime crisis, there are some non-economists in the though, didn’t come as a consequence of room—there is a dam above the village filling that. That was one of the background factors. up with water and the dam is getting too much pressure and it’s getting overfilled: this Consider the zero interest rates in Japan, low is global liquidity. And of course, the wall has rates in the US and, most importantly, the got some cracks in it—the wall is like the fixed exchange rate regimes in Asia. Just regulatory structure—and water always finds remember, if you put all of Asia together its way into the weakest parts and into the broadly as a region managing an cracks and eventually forces its way through. undervalued exchange rate—a region that is somewhat bigger than the United States of In terms of the causes of this crisis, America—then the growth of foreign everyone’s having a go at identifying causes exchange reserves and its recycling has and solutions. We have the Financial Stability quite important effects, as do carry trades Forum (FSF) coming up with all sorts of and the like. things. They want to get better underwriting standards, they want better credit rating Going back to the 1986 tax reform in the US, agencies, they want better risk models, and we also had the concession that allowed they want a better Basel system—all of that things like mortgage-backed conduits to kind of stuff. But in my view, this is quite become possible—where the entity wasn’t narrow and it doesn’t focus on the real taxed and could operate like a ‘pass through’ certificate—which greatly encouraged the use of those conduits to make mortgages. 1 In the US, the Glass-Steagall Act (officially the They didn’t give that concession to equities Banking Act of 1933) separated investment and commercial banking, among other things. The crisis: causes, consequences and lessons for the future. The international perspective 7

causes of the crisis. Those things didn’t good and, yes, they should be fixed. But did cause the crisis. they cause this crisis? No, they didn’t cause the crisis. They facilitated it. Another kind of analogy I like to use is the game of Cluedo. Who killed Dr Black? Was it So when we play Cluedo and we keep pulling Miss Scarlett in the bathroom with a knife? out cards and say, no, that didn’t change, no When you go through the Cluedo cards and it wasn’t underwriting standards, no it wasn’t you ask, was it credit rating agencies? If they corporate governance (because we’ve were causal, did the credit rating agencies always had rotten corporate governance)— change around 2004? all of that kind of thing. Then you pull out four cards that have 2004 written on them. If you I want you look at this chart, because it look at those cards, you will see all those shows you what is at the core of this global background factors of liquidity, tax incentives crisis. It’s spread beyond this because of for debt etc., remix structures—you will see incompetence—and I don’t mince my all those things sitting there. You will see that words—the incompetence with which this four key things happened in that specific year crisis has been handled. If you look at that 2004. chart, you see residential mortgage-backed securities (RMBS). These are the ones that The first thing is: ‘American Dream’ include all those subprime, Alt-A, and other legislation is signed into law. This is the Bush loans that these days they call ‘toxic assets’. administration’s attempt to bring zero equity You will see that around 2004, that pool of mortgages to lower income households as a securitised toxic assets went parabolic. It policy of the Bush government. Of course, was going along quite nicely, together with all this greatly increased the supply of low the other things being securitised, but one quality mortgages ready for securitisation. particular thing suddenly began to explode Second, in June 2004, we had the after 2004. publication of Basel II, so all banks around

the world then became very clear about So if you go through the Cluedo game and exactly what situation they would be facing in you ask, was it credit rating agencies that four years’ time in 2008. were the cause of the crisis? Did they change the way they did credit ratings in Third, in 2004, we also had very important 2004? No. As you see, this blue line is going SEC (US Securities Exchange Commission) parabolically up there, so the question you’re rule changes for investment banks that were asking is: what caused that sudden parabolic not a part of a financial conglomerate. They shift in those toxic residential mortgage- wanted to be regulated. They begged to be backed securities? And, of course, was it regulated. They wanted to be regulated on credit rating agencies? Well, they didn’t the same basis as their European change between 2003 and 2004. competitors, because that would enable them to greatly increase their leverage ratios—I’ll Did the banks change their risk models and come back to that point. use bad ones after 2004? No, they used the same bad ones they had in 2003. So you can The fourth thing that happened was, because go through the list. All of those things are of the diverse regulatory structure in the US what I call facilitating factors. They’re not (where everyone is doing their own thing), 8 Australian Securities and Investments Commission | ASIC Summer School 2009

the regulator of Fannie Mae and Freddie Mac example here. In terms of Citi, we trawled (these two giant monoliths of government through all the 10-K statements of the US, enterprises or government sponsored but it was actually very hard to find. If you try enterprises) imposed a 30% capital increase finding out this sort of information in Europe, on Fannie Mae and Freddie Mac, which led for example, it is impossible. They talk most them into a deleveraging process because of about transparency, but in fact they’re the all the accounting scandals. And when that least transparent region. At least in the US, if deleveraging process was over, the regulator you dig deep, you can actually find it in the basically forced them to not take any new 10-K statements.2 What we did is try and find things onto their balance sheet. out what on-balance sheet mortgages Citigroup had. So those four are key things—and I’ll go through each one really quickly just to give We went through and looked for all their VIEs you a bit of a flavour of it. In 2004, after Basel (that’s ‘variable interest entities’ where the II was published, all the banks participated in bank has a pretty formal commitment) and this Quantitative Impact Study (QIS4) where QSPEs (that’s ‘qualifying special purpose everyone uses their own models to entities’ where the commitment is a little determine their own capital. Sheila Bair more nebulous, although in some cases in (Chairman of the US Federal Deposit those QSPEs they’ve found formal contracts Insurance Corporation), whom I greatly and so on—that means it’s a very dark area). respect, described this process as akin to allowing all the players in a football team to If you look at what was going on, Citigroup at choose their own set of rules, and of course the end of 2007 had $313 billion in it’s very hard to have a football match under mortgages on their balance sheet and $600 those circum-stances. But a number of billion in securitised mortgages in these banks, a good couple of dozen banks, conduits off their balance sheet, the best part participated in this. of $1 trillion dollars in total.

If you look at that row for mortgages, you’ll Now, to that decline in the Basel risk see there down towards the bottom in the weighting system from 50 towards 17. What middle column—depending on whether you people don’t understand—and I have a lot of look at the mean or the median—that they criticisms of Basel II that I won’t go into today were telling the regulators we are going to unless there are questions about it—is that shift because mortgages are less risky. We this is about the transition between one will be able to shift from a 50% capital rate system and another. Because, for the under Basel I to (just taking the average of banks—and you see this with a large number the mean and the median) two-thirds less of them, not just Citi—the question they had than that. So if you had a 50% weight for to ask in 2004 was: well, what do we hold on mortgages under Basel I, a two-thirds cut our balance sheet? What do we put off our would bring it down to a 17% weight under balance sheet? What do we hold on our the sophisticated ‘we determine our own balance sheet under Basel I at a 50% capital capital rules’ kind of system. rate? What do we put off our balance sheet at a 0% capital rate, which will in effect give I mention that because of the next slide. Sorry, Steve, but I have to use the Citigroup 2 Annual summary reports about company performance. The crisis: causes, consequences and lessons for the future. The international perspective 9

us Basel II today? And the answer is, it will So what Northern Rock was doing, while it be one-third/two-thirds—and actually one- was a different issue to Citigroup and it third/two-thirds is roughly what you see in the wasn’t involving conduits or anything like case of Citigroup. that, they were growing their liabilities rapidly through the wholesale market to really get One-third was on-balance sheet, two-thirds into this very profitable area. And when Basel was off-balance sheet and that would give II came in, they were the first UK bank to them 17% weight, because that would be the become a Basel II-compliant bank. They weight when Basel II eventually came in that were going to take full advantage of this and they would have to respect. They didn’t want they had been up to it for two-and-a-half to get to 2008 and find they had to raise years prior to them actually signing up. So I capital and have some sort of crisis on their just mention that. hands. So they were working out what amount they would securitise but still be The other thing—if you followed Basel II and, consistent with Basel II to get the using those QIS4 results (a bit of a profitability—that mixing of equity and credit complicated calculation)—that would be the culture—to get that profitability immediately difference it would make to capital that you in 2004. You didn’t have to wait until you got would need to hold to meet Basel I versus to 2008. Basel II. So, of course, this is a bit of a ‘lead zeppelin’ in the sense that the very thing I just want to read a quote, because a lot banks need at the moment is more capital people dispute whether there is a smoking not less capital, yet that’s what Basel II is gun. Yes, it all works logically, but did a CEO coming up with. say, ‘yes, that’s what we did’? The best I have been able to find actually was not in The second point I mentioned—I’m leaving America but was the case of Northern Rock aside the American Dream legislation (that in the United Kingdom. literally is the term that’s in the legislation, by the way, it’s not me being sarcastic)—was This is the Parliamentary inquiry into the the SEC rule changes. In effect, the SEC Northern Rock failure. Mr Fallon, the agreed to regulate the investment banks Parliamentarian, asked Mr Applegarth the according to the lowest common following question: ‘Mr Applegarth, why was denominator of what was allowed to go on in it decided a month after the first profit Europe, because these international banks warning as late as the end of July (he’s are operating around the world. talking about 2007) to increase the dividend at the expense of the balance sheet?’ It was You will see there on the right-hand side of a very interesting answer. Mr Applegarth the slide the average leverage for all US replied: ‘Because we had just completed our investment banks. From 2004, that leverage Basel II two-and-a-half year process and ratio started accelerating sharply. And that, of under that, and in consultation with the FSA, course, was grist for the mill in the form of it meant we had surplus capital that could be the mortgages under Basel II and the returned to shareholders through increasing American Dream legislation. Taken together, the dividend.’ these four key incentives, these four Cluedo cards that had 2004 written on them, give 10 Australian Securities and Investments Commission | ASIC Summer School 2009

you a very clear picture of that race towards the walls of the fortress came down, you’ll acceleration of those toxic products. see the banks were very happy to move in.

The very last one I mentioned was the These are the facilitating factors I mentioned restrictions put on Fannie Mae and Freddie before in terms of my Cluedo cards so I won’t Mac. You will see the top line is all GSEs— dwell on those. I’ll move to the exit strategy that’s government-sponsored enterprises like and to policy. In terms of the exit strategy, Fannie Mae and Freddie Mac. The first the OECD has been given the mandate to vertical line there shows you when they get look at the exit strategy and the BIS (Bank for the deleveraging constraints on them and the International Settlements), the IMF second line shows you when they weren’t (International Monetary Fund), and so on allowed to take more onto their balance have been given mandates to look at the sheet without permission. After that, and crisis management. And there’s some logical down below, is exactly that same blue line. sense in that: the OECD does long-term The scale looks a bit different there because structural sort of work and the other the GSEs are so big, but at the end of the institutions are more about crisis day when you look at that line there, you see management. exactly the kind of thing that was going on. However, the division between exit strategies What does it mean to a bank like Citi? What and crisis management is very, very blurred does it mean for a bank like Citi to be an in our view, because there are things you can equity culture bank as opposed to the old do now that are not sustainable and silly, and ‘kicking tyres’ type of bank? there things that you can do now to manage the crisis, which are good policy, if you like. You suddenly had a regulation imposed on the securitisers—the people with the quasi When markets are forward-looking and they monopoly on the securitisation process—and look at things like this, they don’t—they’re not they tell you, ‘Sorry, Citi, we can’t buy any holding back at the moment. Basically the more of your mortgages where you’re making key thing is, like the doctor’s Hippocratic income and revenues from selling those oath, to do no new damage. And, of course, things to us’. unfortunately, new damage is being done and quite a lot of it. So the Board sits down and they discuss what they are going to do. One alternative is So in terms of the exit strategy, we’re trying to say, do nothing—we just report to to encourage people to do no new damage, shareholders next time that we have got a to try to select policies that have a big gap in our revenue and we see the share sustainability element in them. And if you do price go down and our bonuses go down. that, and the more you do that, the more the Alternatively, we could create our own markets look at the overall package and say, Fannie Mae and Freddie Macs, or at least ‘yeah, that makes sense’. And the more you accelerate our creation of Fannie Mae and do silly things like, you know, weekend Freddie Macs—these are special purpose mergers of two weak institutions and so on, entities and so on, Cayman Island type stuff. the markets are not impressed at all. The old And that’s exactly what they did and, once ‘two turkeys don’t make an eagle’ is how the markets look at it. The crisis: causes, consequences and lessons for the future. The international perspective 11

In terms of the emerging exit strategy issues was caught short a little bit in all of this and the OECD is looking at, we want to go I’m sure that the FSF and BIS and so on are towards non-distorting regulation, incentive working on this now. I do think that, prior to structures for better risk control, corporate exiting and getting out of all the things being structures that reduce contamination risks, done, you have to have those kinds of things foster level playing fields and the like. Well, sorted out first. you can read it all there yourself, all the good oil. Everyone in this room, Australia being Then once you’ve done all of that, you can one of the few very well-governed countries start thinking about withdrawing the in the world at the moment, will recognise a emergency liquidity, but not precipitously. lot of those terms. Obviously if you withdraw it precipitously, you’re going to cause new problems. If Now, the timeline for exit—this is where I people want exemptions from the sunset want to go through a few things and come to clauses and conditions that are in a lot of a conclusion. In terms of the timeline, our these support measures at the moment, then view is set out there in its essence. Basically, perhaps these will have to be given. That’s the first thing you have to do is establish what I mean by not precipitously, but terms failed institution resolution mechanisms and can be tightened as we get more confidence deal with the toxic assets and recapitalisation in the economy finding a bottom and getting issues. That is absolutely fundamental. Is it a a little bit better. part of the crisis management? Yes, it is. But does it affect how you’re going to get out of We have to unwind the guarantees that this in the longer run? It certainly does. So distort risk assessment, risk pricing. They we are very much focused on that. certainly distort competition. I’ll come back to that. We have to use sensible merger policy We know when this crisis is all said and done to enhance competition and, of course, that we’re going to be left with huge budget reform corporate structures and so on in line deficits—10% of GDP—recalling the 1970s’ with competition and corporate governance public debt problems, guarantees, issues. That’s just an overall summary of it. nationalised banks, pension systems that have been smashed to the ground, insurance Dealing with the solvency crisis, and in terms companies where you just don’t know what’s of establishing failed institution resolution going inside them and, of course, stacks of mechanisms—I probably shouldn’t say this— firms, both financial and non-financial, on I heard a comment the other day from an government drips. analyst at the OECD (so this is not original) who said: ‘Adrian, the United States can be So the question is, how do we exit from all of relied upon to carry out the very best that in a sensible way? Well, the first thing economic policies—after every other you have to do is establish failed institution alternative has been exhausted’. I think we resolution mechanisms and deal with those have been seeing a lot of that going on at the toxic assets first. We’re saying you should moment. really revise and globally coordinate capital regulations and public sector liquidity Because history teaches you—if you go back support, because what’s happened is there’s to the Great Depression and to the 1980s been a big trial and error process. Everyone and 1990s with the savings and loans (S&L) 12 Australian Securities and Investments Commission | ASIC Summer School 2009

crisis, the Scandinavian crisis, and the Think of the pension fund who owns a little Japanese bank crises—that there are some bit of this stuff and who writes to his Cayman very basic things you have to do to handle Island counterparty and says, ‘Please, we the solvency aspect, such as guarantee the want to get our money back at the next deposits. When I say guarantee the deposits, rollover’, and they say, ‘Sorry, these funds I mean extend the guarantees on deposits, are frozen’. He wants to be able to take a separate the good assets from the bad, and decision to say, ‘Okay, we will accept 80 put the bad assets on the public balance cents in the dollar or 70 cents in the dollar or sheet. You can’t rely on private money either, whatever it is’, but you have to have the as in the latest Geithner Plan. Only the government in there making a market to be government can issue risk-free assets and able to do that. exchange them for a risk asset. That is the process we’re talking about. Then of course you have to recapitalise the asset-cleansed banks. Now, what did they The paradox is that it is aggressive public do? Why did I make that joke about you can buying that brings private buying later, be relied upon to do the best after everything whereas if you ask for money from the else has been tried first? Well, they jumped private sector upfront, you won’t get any. from Step 1 to Step 3 and of course you just I mean, think about it: who would put up can’t do that. It’s just standard Economics armloads of money to do this in the amount 101: you just can’t do it, because as the required? Would it be pension funds that are economy goes down, unemployment flows writing into their mandates never to touch this increase, more assets get impaired, the stuff again? Is it insurance companies who banks need more capital—you’re just are trying to get rid of it? Maybe it would be chasing a moving target the whole time. hedge funds, but we don’t want hedge funds playing a part, because then it’s just for In terms of the toxic assets—and this is the leverage. If you get a hedge fund starting to point I’ve been discussing, and one which a buy this stuff, well, I don’t think we have lot of politicians have been talking to me gotten very far. And who are these hedge about in Paris—some of these conduits fund people? We just don’t know. involve toxic assets that are never going to be conforming ones, and they are just very The key thing you need to do is for the complex things. They’ve got ‘knock-ins’ and government to come in there and let ‘knock-outs’ and they’re an absolute mess. Economics 101 work for you. You start off And I just don’t see how an asset with the 2006 AAA-rated, single name, management corporation, like Step 2 of the conforming products, with the government Geithner Plan now being looked at, can buying everything that anyone wants to sell. handle genuinely non-transparent things with What does that do? It addresses the conduit derivatives all through them and so on. problem. You remember that these products are not sitting on banks’ balance sheets. You I think there the only thing you can do is write can’t just get into a bank and deal with it very them down to zero and put them in some easily. These are very complex problems of resolution trust corporation (RTC) type thing. conduits and banks and the interrelationships Maybe you get something back for them. between them. They work them out through the longer run, The crisis: causes, consequences and lessons for the future. The international perspective 13

but you’ve just got to get them off banks’ with the truly genuine, let’s call it ‘churnable balance sheets at this point. toxic’—you know, the stuff that you just have to put a big concrete wall around and deal Of course, once you’ve done that, if it turns with it—and then we recapitalise the banks. out that writing these assets down to zero leaves you with institutions that don’t have Now, I guess all these issues about exit have enough capital, well then, you have to decide come to the fore and the OECD Competition whether you’re going to nationalise them, Committee met on the crisis last week, and close them or recapitalise them. But at least some of the points and recommendations you’ll be recapitalising something that has a that came out of that roundtable were chance to go on with it once it’s done. basically the following. Firstly, that the approach of an asset management I won’t go through this example, but it’s in corporation—if you’re dealing with this crisis your pack. It just gives you an example of the from a competitive point of view—is the least asset management approach, which is the distortive way to go about it, as opposed to, political issue and the point of this slide. say, the specific entities.

Just briefly, suppose you had book assets Secondly, if you’re thinking about the ‘two and liabilities of $2000 and your credit default turkeys don’t make an eagle’ kind of thing modelling tells you that on average—holding and you’re doing those weekend mergers, these underlying collateral mortgages to then a foreign acquisition of a domestic weak maturity—maybe 30% will default and 70% bank is better than a domestic bank merger, won’t. Obviously they would vary mortgage- in terms of competition policy. It’s better to-mortgage and bond-to-bond. But at the competition policy to sell banks in pieces end of the day, if we held these things to rather than to sell them in whole to domestic maturity, they would be worth $1,400 in, say, competitors. Temporary nationalisation is 15 years’ time. That gives you some idea better for a number of reasons than a mega about pricing, that’s 70 cents in the dollar. merger, if it comes to that.

So the Treasury, paying 70 cents in the dollar Finally, you can promote entry through on average for these assets, would be competitive mergers. I’m talking mainly about saying, ‘Okay, everyone’s taken a haircut, the US here, which is still a massive banking your pension fund has taken a haircut and so sector. There are thousands of banks in the on, but the taxpayer is not going to make a US—they can have national and regional loss’. If the pricing is 70 cents in the dollar banks that can be put together to become and we decide to buy them at 60 cents in the bigger and more competitive banks. Which dollar—because the institutions holding them does what? It forms banks that are are desperate to get out—then the taxpayer unimpaired, that are ready to go now, can make a profit and so on. because this is a deleveraging process. You have Citi and all these other banks that don’t So we have set up the failed institution want to lend at the moment, but if you get resolution mechanisms, we have got an healthy banks of a reasonable size coming asset management corporation to deal with together through merger policy—say private things that are single name, conforming equity players come in and put some products (or that might be able to be restructured into those forms), we have dealt 14 Australian Securities and Investments Commission | ASIC Summer School 2009

regionals together—what does that mean entire combined bank and, of course, all the competitively to Citi and the others? other units get basically contaminated by that and the whole group goes down, which is the They’ll look at that and say, ‘My God, this case in most banks. could in the long run be a potential risk to us. We had better not let them eat our lunch. We In fact, we’re not out of the woods on this had better start doing some sensible lending story yet—there are plenty of banks around ourselves or we will find that they take our who are in UBS’s situation. UBS was customers in the longer run.’ bankrupt and needed massive amounts of capital and maybe they’re still not out of the So those kinds of things are really important. woods. But that kind of a structure of We think all sorts of barriers to entry need to contagion risk is really non-transparent. It’s be reduced in that process, for example, not good for corporate governance and it’s a access to credit rating information. You huge contagion risk where loss shifting know, at the end of the day why those banks happens between different parts of the couldn’t get in there very easily, it’s because group, and then bang you get a problem. they don’t know what the customers’ credit ratings are and so on. You need to make Now, there is a structure called a non- those things more available in a competitive operating holding company structure, which I environment so they don’t become barriers to thought I’d talk about. There are two things entry. It’s got to be made easier to switch you’ve got to think of: there’s the non- between banks and so on. operating holding company structure, which is about legal separation of the different And finally—this is one of my hobbyhorses components of the banking group; and then and I’m sure it’s going to be controversial— there are firewall rules. I think both of those but if you go back to the history of the Great things are really quite important. Depression and all the crises we have had, you’ll see these complex conglomerates, and It’s really instructive to look at the history of they were the worst performers in the Great the US, for example. I’ve been having these Depression. There’s sort of a picture of them debates with various people, but when you as these different businesses, but they’re all look at the history of the US, even Glass- the same company, they’re all intermixed. Steagall—which was about whether you could own an investment bank or not—did If you’re interested, read the very good article not have firewalls. You had a 10/20 rule of 60–70 pages of small print on what the where you could own up to 10% in a single regulator forced UBS to do. You’ll get a very affiliate and up to 20% in total under Glass- good idea about why these kinds of Steagall, so even Glass-Steagall wasn’t a structures are a problem. Because if you’re firewalls kind of system. an investment bank, for example, tied to a commercial bank, and you get internal But by 1955 they introduced very strong funding at a cheap rate, what happens? firewalls in the US and those strong firewalls You get to be too big. lasted until 1966 when they were removed. Of course, the period 1955–1966 was a Secondly, all these contagions begin to golden era in US economic growth, so please happen in the investment bank—it takes don’t tell me these rules are going to restrict risks, uses up more than the capital of the The crisis: causes, consequences and lessons for the future. The international perspective 15

competition and innovation and so on. I find improved, but I do think corporate that a very tiresome argument. Encouraging governance could be a ‘catcher in the rye’.3 innovation and growth doesn’t mean cross- And when you look at the companies in subsidising conglomerates through too cheap trouble and the things that were going on, a cost of capital, and groups getting too big which the OECD’s corporate governance and causing systemic problems, that is not group is doing now, the key thing we think innovation. that you have to do is to separate the CEO and the chair of the Board. We think you As I said, after 1955–1966 there were no have to have a risk officer, and that risk longer such firewalls, they were removed. Of officer basically has to have some sort of course, through the 1970s and the 1980s we special employment terms. had various bank failures with the S&L crisis—First Philadelphia, Continental Illinois Obviously, if the risk officer is hired by the and so on—then the subprime crisis and CEO and can be fired by the CEO and his Drexel Burnham and Lambert. After Drexel salary is set by the CEO, that’s not the kind Burnham and Lambert, they went back to of person we have in mind. Fiduciary structural restrictions in the United States responsibilities of directors—these clearly and from 1989 to 1996–97, they had firewalls need to be clarified. Basically, we think if and separation again. you’re on the Board of an affiliate, you’re on the Board of that affiliate and you should be Then what happened? In 1996, 1997, 1998, responsible to that particular group. the US Federal Reserve relaxed the rules and in the end through the removal of Glass- Also, we don’t think it’s a question of an age Steagall in 1999, the US basically allowed for limit for directors or anything like that. It’s a these things. And if you read through what question of how long you’ve been on the the legislation says, it’s just like reading a Board. And there should also be other history of the subprime crisis. limitations on Board membership.

You were not allowed before 1989 to lend to We think you have to strengthen the ‘fit and conduits to enhance the marketability or the proper person’ test for directors. I’m not apparent credit worthiness of those conduits. necessarily commenting on Australia, but You were not allowed to take onto your basically under present fit and proper tests, if books conduit securities; you were not you haven’t committed fraud or have a allowed to warehouse on behalf of affiliates. criminal record, then you’re okay to be a All these things—warehousing, buying director. We think it should be strengthened securities—this is what really contaminated dramatically to include technical expertise, these big conglomerates, so I won’t dwell on risk management skills and so on. So that’s it. I’m happy to argue about it, but I think that corporate governance and I will finish up. is a really important issue that needs to be looked at. In terms of privatisation, when should the government let go of all the banks that it’s In terms of corporate governance, I don’t put it as a causal factor because companies out 3 In the novel Catcher in the Rye by J D Salinger, the there, if you give them bad signals they do main character sees himself as the ‘catcher in the rye’ at a cliff-side rye field where children play tag, in that what they do. Those signals have to be he catches them and saves them from themselves when they stray too near the edge. 16 Australian Securities and Investments Commission | ASIC Summer School 2009

partially or completely nationalised around But in any case, when you’re thinking about the world economy? We think it’s very privatisation, you have to think: well, who’s in important to draw on long-term pools of the regulatory net and the deposit insurance capital. Once again, leverage is too high, so there and the prudential net and who’s not? when you’re thinking about who you’re selling to, if you sell to a hedge fund, say, then that’s It’s not George Soros who is causing this going to increase the leverage. global financial crisis. Why? Because George Soros pays the true global cost of capital. Again, that’s not a really very sensible thing And so I think he’s obviously getting his to be doing in an environment where we’re hands tied behind his back with short selling trying to get leverage down and access long- rules and the like, but those things are really term pools of capital as part of solving this very important points to keep in the back of crisis. And I really emphasise—in just your mind. But we have to decide what is the bringing a finish to the macro aspect here— ‘caveat emptor’ sector and what isn’t and that most countries, and particularly small then stick to it. ones like Ireland, Switzerland, don’t have big enough economies to be able to bail out By the way, I keep hearing people say with financial institutions. Even the United States regard to investment banks that it’s too late doesn’t have enough saving—that’s why the to go back now that we already have these budget deficits are going to blow out. big groups. I don’t think the non-operating holding company structure is overly If you can’t unlock the pools of saving that restrictive in that regard, but the thing people there are around the world from sovereign don’t understand with those institutions and wealth funds, Chinese reserves, and so on, their excessive volatility is they became too then you’re going to have a really big big because of regulatory rules and internal problem dealing with this in a sensible way. funding rules that make the cost of capital too So, we think that this issue is not unrelated to low. And the kind of structure I’d like to see is crisis management. It is certainly good long- one where capital regulations apply to each run policy to avoid excessive leverage, to tap group member according to its risk–return those long-term pools of savings and profile, because that means you can have a basically move to a situation where we align much better regulatory influence on the cost deposit insurance with the prudential rules. In of capital. other words, should we be controlling hedge funds and things like that? Investment banks will be smaller in the future in my view and that’s exactly what they I went to the FSF meeting in March 2007— should be. If that means we don’t have great which was the last one before the crisis—and innovations like securitised products that take I can tell you some very famous people (who mortgages off guys in singlets sitting on are currently doing some very important jobs) verandas without jobs and securitising them, were predicting that the next global financial well, so be it. That’s what comes when the crisis would come from highly leveraged cost of capital is wrong. institutions like hedge funds and private equity. Nobody thought that they would come Now I don’t think I’ve got time to discuss out of the regulated sector, that it would be pension arrangements, but I would say—and the regulated sector that caused the problem. we have had a meeting on this as well in the The crisis: causes, consequences and lessons for the future. The international perspective 17

OECD—that the pension systems have been I’ll now focus on the last slide, which is about smashed to pieces over this. Public competition and protectionism. Again, the confidence in pension systems around the OECD committees have been meeting on world is really in a major crisis. this. In particular, we have to be very sure here that we do not go down the path of Just to make a couple of quick points—there protectionism in this whole policy. For does need to be improved flexibility, people example, with this sort of ‘buy American’ or are going to have to work longer, and there aid to specific institutions, and all the car will need to be changes generally to the rules makers around the world that are all getting on when you can convert to the retirement some form of help now, we need to be very phase from the accumulation phase, and so careful about that. on. And what you’re forced to do with asset allocation choices, whether you have to buy And again, the key to unlocking these pools an annuity or not—whether we should have of savings in sovereign wealth funds and the a more blended system which incorporates like means openness, and openness in terms some defined benefit features—there’s going of being a part of the OECD’s monitoring to be greater pressure to get rid of defined process for the instruments, which are legally benefit schemes, and this is going to worry binding instruments to keep markets open in a lot of people. So in terms of our safety nets the process. and so on, I think we need to keep the features necessary to ensure we don’t lose But I’ll stop there. public confidence in the pension schemes.

Panel discussion Moderator Mr Jeremy Cooper, Deputy Chairman, ASIC Mr Chum Darvall, Chief Executive Officer, Deutsche Bank, Australia/New Zealand Mr Robert Elstone, Managing Director and Chief Executive Officer, Australian Securities Exchange Limited Mr Stephen Roberts, Citi Country Officer & Chief Executive Officer Institutional Clients Group, Australia/New Zealand, Citi Australia Mr Michael Smith, Chief Executive Officer and Director, Australia and New Zealand Banking Group Limited

JEREMY COOPER Well, thanks, Adrian, for that most thoughtful Just getting panel members’ reactions to and detailed analysis. It’s somewhat Adrian’s presentation, was it regulatory humbling and risky for a lawyer to try and imbalances or was it just the bad products summarise what Adrian has been saying to that caused the crisis? Surely hedge funds, us. But I suppose, in its absolute essence, which we have been told for so many years Adrian is saying that possibly regulatory are bad things, surely they had more of a imbalances are really at the root of this role? Or was it really these regulatory problem, and he points to four of those that imbalances? What do you think, Rob? happened in 2004. 18 Australian Securities and Investments Commission | ASIC Summer School 2009

ROBERT ELSTONE been operating. So I don’t think you can say I endorse most of Adrian’s comments. Clearly, it’s only regulation or gaps between the global imbalances that he touched on regulators, frankly. were well-known and were being commented on for four or five years. The unsustainable JEREMY COOPER debt risk premiums were well known and were Mike? commented on for four or five years. It was as MICHAEL SMITH though the system didn’t have the capacity Well, I’d agree. I think regulation has within itself to resolve those issues. obviously played its part in this, but I think

JEREMY COOPER you had too much money basically chasing Thanks, Rob. Stephen? too few good assets. Therefore, you had very smart people manufacturing them, but they STEPHEN ROBERTS weren’t so good. Clearly, as Adrian mentioned, there is not one single factor or event that has led us to I think that the problem has come also with where we are today. It was not a specific the growth of superannuation pension funds. time in June 2007 when the subprime crisis There was this constant demand for quarter- first came to the fore. Adrian went back as far on-quarter improvement in earnings from as 2004 and identified many issues then of a companies they invested in. And earnings regulatory policy nature. per share growth quarter-on-quarter was a mantra, it was a holy grail. How was that I think Adrian’s analogy of a dam is most going to happen? How did you make that appropriate. You have a dam full of global work? liquidity, with financial institutions channelling liquidity in as conduits and moving liquidity The one thing that you didn’t mention in your around as conduits. And that dam was talk was management. It’s all well and good constructed on the basis of regulatory to say you’ve got the right sort of Board arrangements and government policy. And governance, but at the end of the day, it’s fissures were created and exacerbated and management of the company that makes the finally, you saw the dam exploding. decisions. I actually think that there was poor management in these banks. They lost the JEREMY COOPER plot. They lost sight of what they were Thanks, Stephen. Chum? supposed to be doing. You can observe the good banks and the bad banks and the CHUM DARVALL differences between them, so you know there Just following on from what Steve says, I were banks that were properly run and who don’t think it is regulatory distortions. I think have come through this, so far. We will see there are issues within regulations, issues how it pans out. within accounting, issues within rating agencies. They have all contributed. JEREMY COOPER Thanks, Mike. Just picking up on Mike’s If you look at subprime, it’s poor credit comments there, Adrian, you said you didn’t governance, it’s non-transparent financial think that poor corporate governance was engineering, coupled with the most powerful causal, but just focusing on risk. Some global distribution networks that have ever commentators say that one of the problems The crisis: causes, consequences and lessons for the future. The international perspective 19

was that a lot of these products were like with the banking system, and of course that picking up pennies in front of steamrollers for was to their advantage. small rewards—you were taking a very large risk. Wasn’t that ultimately a governance Now, those entities that were inside a problem? Wasn’t it ultimately, we hear ad conglomerate like UBS were able simply to nauseam, about risk management, and yet use the good name of UBS to raise money at the people running these organisations just LIBOR (London interbank offered rate)—this couldn’t see what was happening? is literally what happened—and hand that money over to the investment bank in the ADRIAN BLUNDELL-WIGNALL group. And the heroes in the investment I don’t think that I’d make the point that a bank with their cheap funds invested in a well-run bank can have a CEO and Board CDO to make a nice spread and get a big fat that can act as the ‘catcher in the rye’ in the bonus—thanks very much, we’re heroes. process and steer that institution away from the rocks, because obviously it did happen. Now, maybe in your bank those things don’t go on, but those things did go on and why We have had these weekend mergers that were they allowed to do so? If we had so subsequently weakened a bank that was much grist for the mill for mortgages—low previously doing pretty well. Yes, CEOs and quality mortgages under the American Boards can do a good job. But the point Dream policy—would there have been so about it is, can you rely on voluntary codes much securitisation of these things? No. and telling people, ‘Gee, chaps we hope you all do a good job’? Is that what our policy If we had not changed the SEC rules, which response is going to be? Yes, we will all try let the underwriting process in investment to do better, motherhood and apple pie. I banks lever up from 20 times to 40 times, don’t think so, because there’s always would we have had so much underwriting of somebody who will let you down. And this these securities if they were still as controlled crisis shows there is very little capital in the as they were before those changes? No. I world relative to bank balance sheets that are just don’t know how you can sit there and say massive. regulations didn’t have much to do with this. I’m very happy to believe that a good CEO You know the old banking model is you’ve can make a big difference, but the point of got these massive assets, massive liabilities, that is, you can’t rely on it in a public policy and sitting in between, a little sliver of capital. sense. But with just a little wobble, it’s gone and then there’s a problem. So the problem is Because there’s so little capital, one you have mixed conglomerates incorporating systemically important institution goes under. highly volatile, high-risk businesses where That’s what different about banks. In the cost of capital is too low. For example, competition policy, if a competitor goes under the Basel system gave lending to an in the car industry, they all cheer. Banking is investment bank a 20% capital weighting, very different because of the and lending to somebody who had a public interconnectedness of everything. When a service job got a 50% capital weighting. So it big competitor goes down in banking they was very cheap for investment banks to deal don’t cheer. They cheer when the regulators come in and save their competitor because 20 Australian Securities and Investments Commission | ASIC Summer School 2009

of all the inter-linkages between them. So I JEREMY COOPER think getting regulations right is an absolutely I might stay on regulation. crucial thing. That’s my view. Adrian’s mapped out, for me anyway, just a MICHAEL SMITH series of regulatory interventions that have I don’t think that was what we were saying. caused, not intentionally, but seem to have It’s not just about regulation. Regulation is an caused the wrong sort of behaviour, just one important part and has played a huge part in after the other. You put the regulations on, all of this, and I think we all agree on that. But people seek to arbitrage them, and you take what we’re saying is, it’s not the only thing. them off. They rush in the directions the regulations went. ADRIAN BLUNDELL-WIGNALL No, I agree. What about a world where there’s much less regulation and institutions have to make CHUM DARVALL some of these decisions for themselves, I think you’ve pointed out why regulation is rather than being shown benchmarks and not the central issue. In fact, poor regulation hurdles by government agencies? Anyone can exacerbate. We can regulate all day want to comment on that? every day and we’re not going to necessarily overcome bad management, poor decisions, ADRIAN BLUNDELL-WIGNALL greed etc. I actually do believe that’s quite a sensible thing. I think you have to make a decision Some things have been exacerbated about where caveat emptor sits and where it because we have regulated in such a tight doesn’t, particularly if you’re prepared to way that people are arbitraging the make some reforms to institutions, where you regulation. I would rather see the moral can separate the places where mum and dad hazard argument be emphasised where poor can believe in safe and sound banking and institutions do have greater risk of the market places where investment banking and being the final arbiter. securities markets businesses go on, ad nauseam. Providing those investment banks Now, you’re right about the and securities firms are paying the interconnectedness and that is an issue, but appropriate cost of capital reflecting the we can’t have people subsisting in our riskiness of their business, let it rip, but you’ll industry or prospering in our industry without get sensible decision-making. the risk of failure. And ultimately, I suppose, we are going to see financial institutions and Again, as I said in the speech, hedge funds certain types of activities fail. But it is didn’t cause this. Everybody in the official happening in slow motion: partly because the sector thought they were going to cause the system is necessarily being propped up at next crisis, but they didn’t. And the key the moment so that the failure is almost in driving force there is: they pay the cost of slow motion. Ultimately, some institutions will capital. They’re not arbitraging regulations fail and the opprobrium will fall on those and so on and so forth. So my view is that— institutions and those individuals. I think that and my comments on regulation are really is the ultimate sanction. comments about stupid regulation—I don’t even want more regulation. My view is you’ve The crisis: causes, consequences and lessons for the future. The international perspective 21

got to have smarter regulation, not more have seen commercial banks brought to their regulation. knees by inappropriate lending in certain sectors, often in commercial property. When you ask why do you have European universal banks and why did the US banks In recent history in Australia, we have seen lobby so hard? Just read the letters they that huge volatility within commercial banking wrote—for example, Citigroup—lobbying the for reasons we don’t have to go into now, but regulators to do this, do that, do the other in 1990–91 Australian commercial banks because we can’t compete with European were hugely challenged by inappropriate universal banks, we can’t compete with credit practices. And in some cases, because European investment banks. They lobbied to they had multiple lending institutions under have all of those changes made. the one umbrella (which has largely been stopped within Australia); it was a As Bob Dylan said in one of his songs once: fundamental thing to avoid. ‘The wheel’s still in spin’. That is looking really dangerous in Europe and they haven’t So the notion that there is not an inherent got out of the woods by any stretch of the risk in actually lending money, when put in imagination. So I’m in favour of better the context of economic cyclical downturns, regulation, not more regulation, but making doesn’t bear scrutiny. We have to be careful sure the cost of capital reflects the risk you’re of making observations that are about the taking. here and now. I think you can have the anomaly—if you went back to the 1990s— What’s the point of having a Basel system, that you could have an investment bank what’s the moving part of the Basel system? brought down by a commercial bank. The Basel system of capital weights influences the cost of capital. What the firm ADRIAN BLUNDELL-WIGNALL is trying to do is minimise the cost of capital. Can I ask you a question? Why do you think So it’s about getting that interface right so it is that Australian banks now are ranked in you don’t have cross-subsidisation within the top 10 banks in the world? What was the conglomerate whereby the volatile different about what was going on in investment banking part is linked up with the Australia in terms of the issues we’re talking commercial banking part, and thus can cause about, which is obviously quite different from the whole thing to go under, because that’s what was going on in Europe and the United what we’re seeing here. Citigroup’s States? Why are we looking so essentially consumer bank would never have taken good? Citigroup down in a million years and nor would UBS’s. It was the mixing of those CHUM DARVALL cultures that was the key issue. Well, I can offer some thoughts. I think we learnt from the trials of the early 1990s— CHUM DARVALL credit policy has been very good within the I have to respond. The notion that Australian banking sector. I believe, commercial banking has low volatility and comparatively, we are well-run. We have a investment banking has high volatility (and central bank that has managed things like the that shall always be a kind of a truism) Asian crisis and other things well. The doesn’t take into account the history. We Federal Government has been able to 22 Australian Securities and Investments Commission | ASIC Summer School 2009

generate surpluses, which has given us exaggerated or exacerbated through the some ability to respond to these issues. volume of liquidity and global flows, but I don’t think there’s a disagreement amongst And frankly, the Australian banks largely saw all of us as to why we are where we are some of the securitised mania—especially today. where the black boxes contained subprime assets—for what it was and that they were ADRIAN BLUNDELL-WIGNALL not assets to be involved in. There was no Do you think—with regard to investment mileage for an Australian bank to touch that banks and parts of banks that are investment type of asset. It related in no way whatsoever banks—that leverage ratios of 40 times are to their base business. It has touched us, but appropriate levels of leverage? only at the margin. That’s a simplistic response. MICHAEL SMITH Leverage is clearly an issue that is being MICHAEL SMITH looked at and whether 40 times leverage is I agree with that. There are only two things I too much or too little is clearly a function of would add. Clearly with respect to the capital and so on. In today’s environment, mortgage sector, the mortgage sector in leverage of that extent is clearly not good. Australia is very different from the mortgage sector in the US in relation to its structure, ADRIAN BLUNDELL-WIGNALL being recourse versus non-recourse. Also, When the good times are rolling again, all Australian corporates are fundamentally in volatility seems low and everything is hunky decent balance sheet shape. Those that dory. The good CEOs that we have in place have been highly leveraged are feeling the who let 40 times leverage happen, do you pressure. So I think it’s a combination of think it’s okay that they should be allowed to regulation, corporate management and the do it, a leverage ratio like that? fundamental difference in the mortgage STEPHEN ROBERTS sector. I think clearly prudent management—and for I don’t think we’re far apart in terms of the those CEOs that lived through what we are discussion as regards regulation and the living through today, I think they would extent of regulation or the nature of seriously question whether they would regulation. I will always come back to—we extend that type of leverage within their own talk a lot about risk, we talk a lot about risk management life times—but I can foresee a capital and the cost of risk. Again those are circumstance where several generations manifestations of liquidity or the price of hence we could be in a situation similar to liquidity and that’s what was clearly severely where we are today, be it prudent or maladjusted. otherwise.

The sad thing is we have been there before MICHAEL SMITH on any one of a number of occasions. It I would say, no. I think leveraging that takes place around this time in any economic amount of capital is just mad. If you think cycle and I don’t doubt in my mind that we about a bank and how to run a bank, banks will be there again as the cycle changes. are quite complex industries or complex Obviously, the volatility of this cycle is greatly companies. They operate in a spectrum of customers from ‘mum and dad’ customers to The crisis: causes, consequences and lessons for the future. The international perspective 23

multinational, highly sophisticated issues that have created a pretty good corporates, and every product that those system here and the same can be said for sectors need is provided. Canada as well.

You are probably the highest leveraged ADRIAN BLUNDELL-WIGNALL business in the business community, Do you think if a major international operating at the lowest margin. Therefore, investment banking chunk was available, that your margin for error is actually very low. So the big four Australian banks should be banks should be boring, banks are boring, allowed to put a big investment bank into but they’ve got quite exciting recently and their midst? they shouldn’t be in that space. Banks should be boring institutions and I think that’s what MICHAEL SMITH we have lost sight of. Well, this one wouldn’t, I have to say— I mean, I don’t think we should go anywhere Coming back to your question about why did near that. the Australian banking system look so good—I would say that there’s an element of CHUM DARVALL luck as well. Ironically, the very weakness of Just a counterfactual for you, and that is, the system, which is the reliance on Europe didn’t have Glass-Steagall. It had th wholesale funding, meant that the banks universal banking since the 19 century and didn’t have commercial surpluses to invest. yet it has had relative stability through from Otherwise, I suspect, some of them would the 1930s until recently. I’m not saying that have been buying some of this stuff, but the Europe is not facing huge problems at the money wasn’t there. moment. It indeed is, but I think the counter- factual is, maybe Glass-Steagall was a cause The other thing is that in relation to regulation for a distortion or represented a distortion here, there is a compliance culture, and also, and, when it was removed, the transition was I think that APRA works very closely with the cataclysmic. And the fact that Europe didn’t RBA and I think that’s a very important point. have Glass-Steagall and operated relatively There’s a great relationship. I think when you effectively for the last 60 or 70 years may look at what happened with Northern Rock, give us an insight into the sense that there was ‘dysfunctionality’ between the overregulation or separation can have some Bank of England and the FSA, and we unintended consequences as well. haven’t had that here. I’m not advocating necessarily that Then the other thing is the underwriting Commercial Banks and Investment Banks standards. This is a country where people should be merged—and Mike’s not bidding borrow money and they actually expect to for an investment bank tomorrow—but I think pay it back. It’s a bit unusual that. In the US, the two can stand side by side. Firewalls can that sort of thing doesn’t really happen any be helpful, I agree, but they could stand side more and I think that getting a mortgage by side even without firewalls with proper here, I’m told—you can tell me—is still quite management and proper cost of capital and a difficult. In the US you just have to prove good prudential framework. you’re breathing, so it is a very different situation. I think that there are a number of 24 Australian Securities and Investments Commission | ASIC Summer School 2009

ADRIAN BLUNDELL-WIGNALL history tells us some counterfactuals to the If you’re a bit of an analyst and you go thesis. through the accounts of banks and so on— which I certainly did in the case of Citi when I will comment on Eastern Europe. I think we writing various papers—if you try to do the should think of Eastern Europe in the context same thing for European banks, let me tell of the Asian crisis to a degree and because you, you cannot find out what the heck’s we are in times of precarious sentiment, going on in terms of off-balance sheet people are saying what shall we do? Europe exposures and so on. And when Europeans will have to mobilise. Well, of course claim they have transparency and they shout Europe’s going to have to mobilise, Europe loudest for that in the regulatory community, has a big stake in Eastern Europe and they actually have a number of problematic Europe will need to mobilise to sort this out. issues going on. We didn’t have a European Union (EU) in Asia Pacific, yet Australia and many other UBS is the classic example. The Swiss, for nations mobilised to assist countries we all the usual reasons, said there was no didn’t have any formal political ties with. problem, no problem with UBS. They had 35 Europe is going to have to do the same, and billion euros, or whatever, in capital and there the international organisations (like the IMF) was no problem. Then very soon afterwards, are also going to have to mobilise. a couple of months later, they suddenly needed three times more capital than they I think the hysteria of the moment is had prior to the crisis via a direct government presenting some of these problems as injection, but they were supposedly fine. insolvable, but they will be solved through time. I think those issues of lack of transparency and Europe’s tradition of the government MICHAEL SMITH basically stepping in and being prepared to Chum, just on the Asian crisis—it’s been said top up the money like that, is a part and that in fact the medicine that was parcel of the whole European story. In administered there was too harsh, forcing all Europe, if you wait until the dust settles, you of the victims, if you like, to build up massive are seeing the exposure of the European surpluses to sort of tide them over. Then that banks to Eastern Europe, which is proving to money fuelled a lot of the problems we’re be the next leg of this crisis. These things are seeing at the moment. What do panellists really unwinding, European banks are going think in terms of solving Eastern Europe? Are to need a lot of capital and the downturn in we just running the risk of creating further economic activity is like 8% annualised in the problems down the track? GDP fourth quarter numbers for countries CHUM DARVALL like Germany, this is really taking off now. Well, I guess I’d say that the Asian surpluses

CHUM DARVALL were built up because of hearty US consumer I’m in no way down playing the gravity of the appetites in times of cheap money rather than current situation, and I agree with the anything else. Whether the Eastern Europeans comment on transparency. You shouldn’t cry have the industrial ability to harness their wolf on transparency then present non- recovery and create, frankly, a ‘miracle’ transparent results, but I guess my point is recovery—or what could be called a miracle The crisis: causes, consequences and lessons for the future. The international perspective 25

recovery—as Asia is, I’m not sure. Each of portfolio invariance idea in the way the these things plays out in a different way. regulations work is a crucial kind of issue for policy. And of course, governance and so on ADRIAN BLUNDELL-WIGNALL should be running companies and The real problem is the fixed exchange rate management well, but at the end of the day regimes with Europe and so on. If you have you can’t rely on it. You have to give the right an exchange rate crisis in Eastern Europe, incentives, because there will always be the exposures of these foreign currency someone who will try and arbitrage what loans for businesses and households are just looks like a profitable thing in the good times absolutely devastating, and that just leads to when volatility is low. impairment. So this is where regulation comes in. JEREMY COOPER I wanted to ask a question about I did want to say one more thing about the securitisation—the ‘originate to distribute’ regulatory arrangements if there’s time, model passing on these income-producing which is that a key thing about safety and assets without having any skin in the game regulation and so on is the role of so to speak. Rob, how is that market going to diversification. be resuscitated? Will we see that model slowly come back to life? Or is the whole way If you look at this crisis and the sequence in that securitisation is going, going to have to which it began to unfold, it basically kicked change? off with Bear Stearns. It went through the stand-alone investment banks pretty quickly. ROBERT ELSTONE Citigroup came in pretty quickly, UBS came I’m loath to say anything with Greg Medcraft in pretty quickly, so everyone who was in the audience, because he’ll shoot down involved in investment banking came in, and anything I say, being an expert in the field. who else? It was the mortgage specialists. But it is both inevitable and desirable that the market here comes back in the form that it So basically, if you were not diversified, or if was prior to the breakdown. I support Mike’s you had a big exposure to investment comments really. It wasn’t as though banking, you were in the vortex of this kind of Australian banks weren’t preaching the crisis. And one of the lessons there—and ‘originate, warehouse, distribute’ mantra. what regulators do need to have a look at They were. It wasn’t as though they weren’t again—is this issue of portfolio invariance in creating special purchase vehicles as vehicles the Basel rules, which results in a linear type to get balance sheet assets off. I think it was of system that does not penalise portfolio just the degree to which that was happening concentration. So if you’re a mortgage here. It was nothing like on that scale. specialist, and you just had mortgages, of course you were going to be killed by this If you look at the asset mix of your classic crisis. If your investment banking was heavily Australian trading bank, it predominantly— involved with underwriting and so on, these possibly with the exception of NAB (National types of products, of course you were going Australia Bank)—it looks more like a mortgage to be killed in this crisis. bank on the numbers. And the mortgages that have been originated over several decades So getting the right type of diversification is haven’t been anywhere close to the deeply out really important. And again, getting rid of that 26 Australian Securities and Investments Commission | ASIC Summer School 2009

of the money product types that were Look, I’m fundamentally a believer. I think the originated in that 2004 window. domestic securitisation model was a superbly designed and well-executed piece of So I think the conundrum we have is, we architecture. It should come back and it should need to be wary of government intervention come back without too much government to try and re-kickstart that market, because support and intervention, in my view. that can distort the price signalling effect of a market that has really just temporarily JEREMY COOPER paused in Australia, rather than being in This is a question perhaps for Stephen and need of radical surgery to get it restarted. Chum: Adrian’s given hedge funds a bit of a leave pass in all of this—that is, that they It won’t restart, in my view, until credit weren’t part of the cause of the problem. markets generally start to normalise and that Interestingly, though, they weren’t much part won’t happen, as we have all said, until this of the solution either. We have heard that the issue of recapitalisation—taking the toxic banking system had almost ceased to exist, assets off balance sheet in the European that the new source of liquidity and and US banking systems—will allow that to intermediation was hedge funds and that happen. they should have been able to vacuum up all these toxic assets and trade them between The guessing game of whether it’s six, 12, each other and there would be no problem. 18 months away I think is pointless, because That absolutely has not happened. What do there are certain prerequisites before it can you think the reasons for that are, Stephen reopen naturally. But I think we just need to and Chum? be careful also. In the early part of this conversation, we were discussing the STEPHEN ROBERTS regulatory framework. We need to be very, I think when you look at hedge funds—and very careful. we have raised the topic that hedge funds are not necessarily a cause of where we are Adrian has talked about what I think is the today—but I think the one thing about hedge DNA of the regulatory framework, which are funds, which we cannot discount, is that they the firewalls. The absolutely fundamental are fundamentally very highly leveraged architecture of whether capital should be institutions. allocated according to the riskiness of specific asset classes and activities. If you look at one sector of the financial markets that has been, and will continue to There have been other high profile examples be, dramatically impacted by what we’re of regulatory failure. I think the obvious one going through, it is hedge funds. I think there that’s getting currency—with the autopsy is no other single sector where there have going on since particularly the events of last been as many failures due to that leverage. September—has been the credit default And I think that’s the reason why we haven’t swap market and the interplay between that seen them as a potential conduit for solution and the ability to short bond markets. That’s for what we’re currently going through. probably equally a standout example of regulatory failure that is very, very specific to So, certainly from a blame perspective I one particular activity that transcended agree with Adrian. But I think there is another multiple markets. The crisis: causes, consequences and lessons for the future. The international perspective 27

part of the equation with hedge funds that So, yes, I would say, yes—the hedge funds we’re experiencing at the moment, which has have not been a cause, but the question is: come about through the very nature of their at the margin, have they been good leverage and the extent to which that is stewards? Some have, but they are the ones manifesting itself in hedge fund failure. who are more institutionalised and they are the ones that will be able to cope with some JEREMY COOPER regulation once this is all over. Mike used the term ‘boring’. Banks should be boring. I think that’s a view I’d concur with. ADRIAN BLUNDELL-WIGNALL To some degree hedge funds—if we just put Just to be clear about the facts here, the leverage aside—the most basic mistakes though—hedge funds are not nearly as in ‘plain vanilla’ asset and liability leveraged as investment banks. I mean, the management that we all learnt at university way they measure leverage of the hedge have been made in that particular sector. It fund is like the client’s capital versus their goes again to the incentive arrangements, exposures. And, typically, it’s like four, five the front ending of the fee arrangements, and times is the kind of number you see on the lack of constraint on leverage in that average. Whereas, when we talk about 40 sector. I think that has been a large part of times for an investment bank—yes, hedge the problem. funds are highly leveraged, but boy, what do you call investment banks in the lead-up to CHUM DARVALL this crisis? I mean, that’s highly leveraged I’d agree with Steve’s point about leverage. and that’s the regulated sector. I also agree with Adrian’s point that hedge funds haven’t been a direct cause of the Regulations promote safety and everyone whole problem. What they have been, in a assumes if you’re regulated, that that’s where number of cases, are poor stewards of the moral hazard issues come from. There’s investors’ money. And the dramatic failure less moral hazard in the case of hedge rate, which Steve touched on, has suggested funds. In the good times, when volatility was to me that they need to be more so low and everyone thought this was going institutionalised. And the one thing that will to be forever, the big trade—whether you’re a come out of this is the unregulated, or the hedge fund or not—was the one that lightly regulated, will be regulated. basically took the low risk activity. It was the low risk activity that blew everybody up. One of our senior funds managers from New York has as his mantra: ‘If you want to invest It was basically saying, if you could borrow at in any sector within the context of today, you LIBOR and put it into a CDO, for example, have to invest with people who are currently you would have a small spread and make regulated or are “regulatable”, because hardly any dollars out of it. What have you regulation is coming’. An institution that can’t got to do? You’ve got to leverage it 40 times cope with regulation is not one necessarily to make some money out of it, and it’s those that should be able to receive vast amounts trades that blew everybody up. It wasn’t the of pension funds and so forth, because macro hedge funds and so on who were regulation is coming in different forms. taking long-short positions, it was the safe trade that caused you to leverage many more times than was prudent, because of the 28 Australian Securities and Investments Commission | ASIC Summer School 2009

smallest of spreads. That’s what blew STEPHEN ROBERTS everybody up, whether you’re a hedge fund I think I’d add two comments with respect to or an investment bank. both hedge funds and the overall causality issues here. CHUM DARVALL Can we put this leverage concept in context? The first with respect to hedge funds: they We’re not talking about regulatory leverage, are a function almost by definition of a we’re talking about gross leverage, are we positive market environment. And where that not, Adrian? What has occurred here is that environment changes, funds flowing in by people have forgotten to look at their overall definition are going to start to drop off and balance sheet. They worried about all the hence exacerbate further any issue of regulatory niceties, about whether an asset is leverage, be it 20 times or 40 times. 50% or 20% weighted, but the leverage that Adrian is talking about is gross leverage, raw The other issue I’d come back to is: my unweighted leverage of assets. And by that perhaps somewhat ‘tongue in cheek’ measure it got to more than 40 times, and I comment at the outset, which was you still agree that is just way too high. Frankly, the cannot afford to lend to institutions or people banks fell into a false sense of security that who don’t pay back. And I think that really certain assets (Northern Rock and gets to the heart of the problem. Whether it is mortgages) are weighted 20% etc. leveraged or unleveraged, the fundamental issue is still around the assets that were put In times of crisis, that’s bunkum. If you’ve got on balance sheets with very little hope of a balance sheet that’s 40 times leveraged, repayment. Be they leveraged or not, if you still have to be able to delever in a quick there’s zero chance of repayment, it doesn’t way. You still have to find the cash to support matter if it’s 100 times leveraged—you’re still those kinds of assets. As we all agree, that is going to have a fundamental problem. just too extreme. ADRIAN BLUNDELL-WIGNALL The hedge funds were still levered If you don’t have enough capital in the institutions. I spoke with a major hedge fund banking system, yes. in the last 48 hours for convertibles that were being offered leverage by the investment MICHAEL SMITH banks again at 3 to 1. At the peak, leverage But back to the original question—hedge of 20 to 1 was available. That was reduced in funds are part of the solution here, they have two or three stages back to 1 to 1 and that’s to be. Hedge funds and private equity play a a reason why some hedge funds in that very important part in the corporate world. space collapsed. So if you want a green The banks can’t provide sufficient financing, shoot in spring, well-run hedge funds are they just can’t. The fact is that hedge funds being offered slightly better terms and pay the real cost of capital and, therefore, conditions in the last few weeks. So it went they should be efficient. from one extreme to another—20 to 1 was The fact that a number have failed really extreme. No leverage was an extreme reflects that their model was based on a cost response. Now maybe we are finding a of capital that was much lower in an balance. environment where it hadn’t changed very much. And we got into an environment where The crisis: causes, consequences and lessons for the future. The international perspective 29

the cost of capital has increased significantly, MICHAEL SMITH so that model didn’t work. But again, a well- Here? No. run hedge fund is, I think, a very important part of the financial services sector. JEREMY COOPER Do you think elsewhere in the world there JEREMY COOPER might be experiments with going below zero? Now, we’re going to have to speed up slightly because I’m sure the audience will want MICHAEL SMITH some questions. So I’ll just quickly ask a few I think people will resist it. I think in reality, questions and then we will have a bit of a though, real interest rates may well go below mini wrap-up, then throw questions out to zero. participants. It’s going to be very difficult to achieve and One quickly for you, Stephen—is the I think the lessons learned in Japan were investment bank dead or is it just on life interesting ones. I think the issue is more in support at the moment? the way of, where do you go with the currencies? And I think the problems that STEPHEN ROBERTS countries like Ireland, Greece, Portugal The investment bank is not dead clearly. have—being part of the euro—is more There is still a significant need for advice, for significant, because where do they go with underwriting, for access to capital markets this? that have been the traditional domain of investment banks. So, no, they are not dead. JEREMY COOPER Chum, we talk with some nervousness I think the number and the way in which they sometimes about foreign banks in Australia operate—whether they are attached to and them taking their capital away, and we universal banks or otherwise—will change. tend to have a bit of nervousness about that. I think the ground rules under which they Should we be concerned about foreign operate will change, but the fundamental banks? reason for the existence of investment banks has not gone away. It has been in existence CHUM DARVALL from the time—well, forever, and that won’t I think the reporting of the demise of the change. foreign bank in Australia is greatly exaggerated. The foreign bank community is But I do believe there will be a consolidation, not homogenous. You could create a number I do believe there will be a change in the way of different categories, but maybe in today’s they’re operated and regulated. And I do context the three broad categories are: believe they will continue to be part of, in nationalised foreign banks; representative some circumstances, multi-product offices; and unimpaired banks with long institutions going all the way through to commitment to Australia. The representative specific boutique operations. offices in many cases have pulled back and they will participate less in providing JEREMY COOPER Australian corporates with funding, I believe. Mike, are we going to see negative interest rates, do you think? The nationalised banks are an interesting category and they speak to a much deeper 30 Australian Securities and Investments Commission | ASIC Summer School 2009

challenge. There will be a tendency to all this going to last? When are we going to encourage them to withdraw their capital hear the first birds of spring singing? back to their home markets. And that needs to be resisted, because we can’t have an CHUM DARVALL impeding of global capital flows in a time of I’ll have a shot. I think we’re at half-time and crisis. We can’t have banks being persuaded we’re having the orange break. We’re moving by home politicians, in some cases, to take from the potential of financial systemic their capital back, because that will only failure, now we’re moving into the real exacerbate the crisis. We need to encourage economy and the horrendous results of it in nationalised banks to continue to do terms of unemployment and complete loss of business in Australia. Then there’s a raft of confidence from the consumer in some other banks and they are performing more or cases, and we’ve probably got another two less as normal. years at least to go. But the green shoots are around us. We have extremely low interest It is fair to say that foreign banks provided rates. We have huge stimulus packages and 40 to 60% of syndicated loans under some some of the debt markets are beginning in a measures. Now that may not be as high, but rudimentary way to work again. the foreign banks will still have a very important role to play. There are a group of In the last two weeks Roche raised in excess foreign banks that are specifically worried of $30 billion in the world’s capital markets about the Sons of Gwalia issue, where equity and they raised, I think, $14 billion or $15 holders might achieve an elevated priority in billion in a single day in the US. Roche is a windup. rated AA, but we can’t ignore these signs of confidence in the capital markets by the very So I think if one had to look at a specific best borrowers. issue to get clarity on—with a view to encouraging some of the main foreign But many, many sectors are not working. lenders—then that would be one to focus on. We have got Eastern Europe and other sovereigns to deal with. We haven’t seen the MICHAEL SMITH full drama of the challenge for commercial All banks are worried about that. property refinancing. That’s all ahead of us. We haven’t seen the US dollar supremacy CHUM DARVALL challenged in terms of further volatility, so I’d Yes, all banks are worried about that. say we’re half way.

JEREMY COOPER I’ve got one last question. Then we better throw it open to the audience. How long is The crisis: causes, consequences and lessons for the future. The international perspective 31

Questions from the audience (names withheld)

JEREMY COOPER outs—you name it. There’s a churnable core Thanks, Chum. Now, we really will have to that you’re just not going to be able to deal throw questions to the floor. with in that open market kind of way, so I believe the Geithner plan at the moment is Question 1 more like that asset market approach. I think This question is to Adrian. You mentioned it makes the mistake of trying to rely on that one of the best ways to handle the crisis private money to go hand-in-hand with the would be to separate good assets and bad government, which isn’t really going to assets via government intervention. I just happen in any way meaningful. So it’s going want you to comment briefly on what would to require the government to do it, but when it be the best ways to address moral hazard in comes to these toxic assets, the really toxic these situations? Would pricing be the best churnable stuff, well, I don’t think there’s any way to address these or should we just wait way to do it other than to write them down to until after confidence is re-established to zero. The companies wear it. This is all part address moral hazard? of the auditing of a bank.

ADRIAN BLUNDELL-WIGNALL To say what is a cleansed bank, what does it I think for me the most level playing field look like? To me, that genuinely toxic part way to do it is to use the asset management just has to be written to zero and taken off corporation approach, because it does a the public balance sheet into an RTC number of things. In all the previous financial (resolution trust corporation) type thing and crises, you’ve got to remember that, in regard looked at. And then when you’re looking at to toxic assets, we had lessons in the S&L the banks—where you’re well through this crisis, we had lessons in Scandinavia, we asset management corporation, buying had lessons in the Great Depression and so conforming type of products, you’ve taken on. the genuine churnable stuff off—then you look at the situation of the banks and say: But in no case have we had a crisis with toxic well, let’s capitalise them back up to the level assets where we have this particular where they can operate again. There’s complication of the conduits. You know, always going to be moral hazard in saving these conduits are very complicated things, banks and using deposit insurance and so on and everyone’s trying to figure out to what and so forth. I think that’s the only fair way to extent—either economically or formally—are do it. people attached to them. And if you have a system that tries to address the issue by just Question 2 looking at banks and nationalising banks and Adrian mentioned in his introduction the so on, you’re not addressing these conduits. OECD’s latest thinking on corporate So the most level playing field way to do that, governance. I just wondered if the panel with the least moral hazard, I believe, is to would just comment on a couple of those actually do the asset management approach. issues: the role of the risk officer, fit and proper person, and the tenure of Board But as I said there are so many non- directors? conforming types of products out there with complex derivatives—knock-ins, knock- 32 Australian Securities and Investments Commission | ASIC Summer School 2009

STEPHEN ROBERTS MICHAEL SMITH I’m happy to have a go at the risk officer, We were talking of risk officers here in the because to me that is really at the heart of context of banks, yes, and financial so much of what has happened. When I institutions. said earlier that to me the price of risk was inappropriate as a function of so much I actually think the CEO is the chief risk liquidity, the risk officer therefore to me is officer. What does the bank do? It manages really a price maker and really is the most risk. Unless the CEO is right on top of the important conduit within any type of financial risks that the organisation is taking, then institution. frankly you’ve got a problem. So I accept that you need a chief risk officer as well, but I I agree with Adrian’s comments in relation don’t agree with the view that they should to where the risk officer should sit within an report to the Board separately. I think the organisation, how they should be evaluated CEO and the CRO should work very closely and compensated. But in the context of risk together and that actually is the culture and being the price of capital, I think therefore the ethics of the organisation—it should flow that the risk officer should often be the price from that. maker, not directly obviously, but in so far as the management of liquidity. In terms of tenure of directors, I think that that makes a lot of sense. I think that there JEREMY COOPER are various models, but I agree with the fact I’ll step in on ‘fit and proper person’ and that people can become stale, they become endorse Adrian’s comments in his formal too close to an organisation and, indeed, you presentation. I think we probably all agree need the refreshment, so I think that that is that, if a traffic fine or a prison sentence is appropriate. the criteria, as long as you don’t have one or both of those, then the bar is far too low in As for the term, I think different industries terms of fit and proper person and more need different amounts of time. But I would thinking needs to be applied to that. have thought to be a director, I think five years is too little and 10 years could be the There’s the age-old debate about direct limit. I think a director becomes effective after independence versus subject matter probably two years and really starts to experts on Boards. I have a clear bias understand the business. So if you can get towards—particularly in banking, financial eight years of value, I think that that makes corporations—that subject matter expertise sense. is actually far more important than independence. It’s probably unfashionable CHUM DARVALL to say that, but I say that from first hand Just on the risk officer—I think that the experience. I really do think fit and proper concept at the moment in some places is that person is something that has to get taken the risk officer looks after credit risks, legal very, very seriously, because it is far too risk, compliance risk but not market risk and loose the way it’s passed through legislation. that to me is kind of a flaw in the system. Our own institution—I can speak for Deutsche Bank—now has all those risk areas reporting to one person, and I completely agree with The crisis: causes, consequences and lessons for the future. The international perspective 33

Mike’s comment that the CRO and the CEO caning us here—our market share is really need to be working hand-in-glove. dropping. Then the pressure is to say, ‘Well, stuff it—let’s go’, and that happened in this MICHAEL SMITH crisis. So the question is, how do you stop I think the key risk for any organisation is that? Make the risk officer the CEO? I’m not reputation. sure.

That has more value than anything else, and MICHAEL SMITH perhaps that’s the one thing that the banks I don’t think you would actually stop it just didn’t look at, or the investment banks happening. I think it depends on what the particularly. They didn’t care what happened culture of the organisation is like and you’ve to their reputation. The individuals didn’t got to take away some of the short-termism, care; they were worried about their $100 and that’s one of the real problems. You can’t million bonus or whatever and the actual run a bank on a short-term basis, you’ve got reputation of the organisation meant nothing to look at the medium and long-term and I to them. I think that’s an issue. think that’s what was lost. Again, it was personal benefit rather than corporate benefit ADRIAN BLUNDELL-WIGNALL that was at work here. To further push you a little bit on this, there is this issue about too big and complex to Now, I guess by making the risk officer report govern in a complex kind of organisation. to the Board, or the head of audit report to the audit committee, all these things that There was a lovely press quote, for example, people put in place are not going to from Robert Rubin of Citigroup where he was fundamentally stop the problems. The culture asked, ‘Well, you’re so smart, you know, of the organisation starts at the top and you you’re Goldman Sachs, you’re really clued in have to push that down and ensure that that here. How come you let this happen?’ He is solid. As I say, a bank shouldn’t be a was saying, ‘Well, we hire people to look at growth stock; it should be a boring stock. all the risks; it’s too complicated. I was just some kind of sideshow. I wasn’t on top of it JEREMY COOPER: basically.’ It seems to me there was a lot of We have gone over time, so a thoughtful technical issues here that, even though you discussion about risk is probably the way to may be the CEO, should you be the risk close this. I’d like you to join with me in officer? thanking Adrian for a most detailed and thoughtful presentation and also the There’s another risk there too, of moral panellists for keeping it lively, keeping it hazard, because you’ve got the issue where moving. And I’m sure you’ll agree it’s been things are looking really good and you’re a most informative session, so thank you getting pressure from Deutsche Bank or UBS Adrian and the panellists. or someone, and you think: they’re really

34 Australian Securities and Investments Commission | ASIC Summer School 2009

The crisis: causes, consequences and lessons for the future. The international perspective 35

Source: Basel Committee, FDIC, author commentary

36 Australian Securities and Investments Commission | ASIC Summer School 2009

The crisis: causes, consequences and lessons for the future. The international perspective 37

38 Australian Securities and Investments Commission | ASIC Summer School 2009

The crisis: causes, consequences and lessons for the future. The international perspective 39

Source: OECD

Source: OECD

40 Australian Securities and Investments Commission | ASIC Summer School 2009

The crisis: causes, consequences and lessons for the future. The Australian perspective 41

MONDAY What went wrong and what we’ve learned The crisis: causes, consequences and lessons for the future. The Australian perspective

Mr Ian Macfarlane AC, former Governor of the Reserve Bank of Australia, and Director, Woolworths Ltd, ANZ Bank Group Ltd and Leightons Holdings Ltd

IAN MACFARLANE Many words have been written about the variables such as falling exports or falling causes of the international financial crisis, export prices. Not any more is that the case. including quite a few by me, so I’m not going Exports and exports prices fell but they were to go over that ground at all today. We have very late on the scene, well after the financial already had that covered in a very shock had already done its damage. informative first section. Instead I’d like to see whether we can draw any lessons for Since the international financial crisis was a Australia from it, now that we’re nearly two credit event, the first effect on Australia was years into it. I think there are a few sobering through the credit channel. Borrowing lessons that stand out, which I’ll go through. abroad, particularly for medium and longer term, became more expensive and, for a time Lesson number one is that in an international late last year, unobtainable. disturbance of this size you cannot stay out of it. Even if your own economy was in The second channel was through equity reasonably good shape—robust growth, low markets where all countries experienced a unemployment, low inflation and a stable major fall, irrespective of whether their financial system—you still get caught up in it. domestic economies were weak or strong. Furthermore, I think that during this crisis the Every country experienced an approximate international financial markets did not halving of their equity prices, and more than discriminate much between countries that halving for financials. were growing, or those that were in An interesting irony is that Australian shares recession, or between countries whose until recently fell by slightly more than US banks were making profits and those where shares. Again, as I said, I don’t think the they were making losses. So that’s lesson international financial markets during this number one: you can’t stay out of it no matter particular crisis have discriminated very well. how virtuous you thought you were. The resulting loss of wealth because of this Lesson number two is that if the international halving of the share market has had a bigger shock was a financial one, as it was bound to impact on the household sector than earlier be, the transmission of that shock to episodes, because the household sector is Australia will be via financial channels and now so much more exposed to financial risk, confidence. When I was a student we were particularly equity prices. taught that international disturbances were A third channel, again really a financial one, transmitted around the world by real slightly later than the equity channel, was 42 Australian Securities and Investments Commission | ASIC Summer School 2009

through commercial property where, when Secondly, again I think we’re in the right part we observe the prices of listed property of the world. Our large resource sector and trusts, we can see those drop by 30% or 40% our relatively high dependence on Asia in virtually all countries. meant that we were more exposed to the faster growing, although slowing, but still Fourthly, and by no means least, consumer faster growing parts of the world, and less and business confidence fell sharply. And, of exposed to the US and Europe. course, this was no surprise since everyone was reading or listening daily to tales of woe Now, thirdly, and this is really where the and disaster from overseas, as banks and speech starts. The most interesting lesson other formerly reputable businesses were we learned, and I think in many ways the being rescued by government support brightest spot in the generally gloomy packages, or in an extremely important case, outlook, is that our financial system— not rescued. I’m referring to Lehman particularly our banking system—was more Brothers, of course. resilient than virtually any other OECD country. It did not take on the increased As a result of all these effects, there was a degree of risk that led to the downfall of so generalised tightening of belts as households many well-known institutions in the US, the and businesses cut spending and sought to UK and Europe. Our government and central pay down debt. Finally after all this was well bank have not had to provide capital advanced, the real side impact of lower injections to banks, nationalise lenders or exports and lower export prices resulting buy toxic assets to prevent insolvencies, as from the international recession started to has been the case in most overseas kick in. countries.

Now, enough of this gloom. What, if any, Why was this so? Well, in asking why were are the bright spots from an Australian the Australian banks resilient, I want to start perspective? There are actually quite a few, the other way around. but I’m going to go through the ones we already know about rather quickly and come Let me start with a few comments about why to two that I think haven’t been given the so many banks in other countries got into attention they probably deserve. such severe difficulties. Our grandfathers, such as those who wrote the report on the Going through the strong points for the 1937 Royal Commission into Monetary and Australian economy—well, first: the starting Banking Systems, would not have had any point for our monetary policy—our fiscal difficulty understanding it. They recognised policy and our exchange rate gave us more that when you have intense competition room to move in an expansionary direction among inadequately regulated banks, it than for other OECD countries. We started always leads to excessive lending, with an interest rate level of 7.25%, with underpricing of risk, excessive risk taking and fiscal policy that had virtually 10 years of a financial crisis. The crucial word in this surpluses and an exchange rate that was in sentence is ‘intense’. Why was the the high 90s. You could write a whole speech competition in banking so intense in the on that, but that’s all I’m going to say on that countries that got into trouble? subject at the moment. The crisis: causes, consequences and lessons for the future. The Australian perspective 43

There are many explanations, a number of Netherlands, France and Germany the same which I have spelled out in previous process was occurring. speeches, to do with the reward structure within banks and other incentive structures There’s a paragraph in Adrian’s paper that is relating to rating agencies and mortgage saying the same things—that is, banks originators and all the rest. I don’t want to go stopped having a banking culture and over those again today. We have already developed an equity culture. The unanimous done that at length before. view among bankers is you had to get big otherwise you would be swallowed. You had But there’s also another explanation that we to achieve a higher return on equity and have have all tended to overlook, which I’ll now a higher price earnings (PE) ratio than your explore. It starts from the recognition that no competitors or they would take you over. In competition is as intense as the competition order to do this, you had to take more risk for corporate control. It drives management and in time we now know, excessive risk. to take bigger risks than the normal competition in the goods and services Why didn’t it happen here? Well, there was markets. If every day you think your nearest certainly competition and there is competition competitor will take you over, it concentrates to provide banking services to customers and the mind wonderfully, and recent decades in I think there was some increase in risk taking banking have been the story of takeover after by our banks and a reduction in lending takeover. standards. I remember giving speeches warning about that two or three or four years Now, I haven’t got the resources to do a ago, so it happened here to some extent but thorough research, so I can’t give you a nothing like the degree seen overseas. blow-by-blow account, but I’ll just mention some of the ones that spring quickly to mind. It’s hard to avoid the conclusion that the In the UK all the merchant banks got taken difference was there was no competition for over (some no longer exist) as did such corporate control in Australia. That saved us household names as Midland Bank and from the worst excesses that characterised National Westminster Bank. In the US the list banking systems overseas. Why was there of names that have disappeared well before no competition for corporate control? It was the current episode includes Salomon not permitted by that curious creature: the Brothers, Kidder Peabody, Paine Webber, ‘four pillars’ policy. I call it a curious creature Dillon Read, Bear Stearns, Smith Barney and because it’s not enshrined in legislation, nor, many more. They were investment banks or to the best of my knowledge, is it imposed by brokers, but it was the same story with the regulations of the ACCC (Australian commercial banks. Competition and Consumer Commission) or APRA (Australian Prudential Regulation I can’t go through them all but the typical Authority) or ASIC. It’s a stated policy of the sequence was when Chemical Bank took last three Australian governments and is over Manufacturers Hanover (Manny Hanny), supported by the general public as far as we which in turn took over Chase and kept the can tell. It is loathed by the CEOs of major name and then took over JP Morgan and Australian banks who have all spoken out kept the name. Even in Switzerland, the against it. They felt that it prevented them from growing bigger and being able to hold 44 Australian Securities and Investments Commission | ASIC Summer School 2009

their own in international company, where the merger proposals, the Government (under survivors were getting bigger and the Finance Minister Paul Martin) adopted a minnows were disappearing. policy that effectively ruled out takeovers or mergers among these banks. His arguing for The most curious thing about the four pillars his decision was based largely on prudential policy is that its aim has always been to considerations. maintain or increase competition, it being felt that the present four major banks would President Obama said before his recent visit provide more competition than the two that to Canada—or someone said who put it in would be implied by the abolition of the his speech—the performance of Canadian policy. So the quiet irony in my view is that banks alone among those of the Group of the policy has made a positive contribution to Seven nations in not receiving a government improving the stability of our financial system, bailout is striking. Paul Volcker, the but not because it increased competition, but ‘eminence grise’ of central banking and an because it reduced it to manageable levels. Obama adviser on US banking regulations said: ‘It’s interesting that what I’m arguing for In any event, we now find ourselves in the looks more like the Canadian system than position where nearly a quarter of the world’s the American system.’ highly rated banks are Australian. Of the world’s 100 biggest banks, only 11 are rated Well, it would have to. Anything would have AA or above by S&P (Standard & Poor’s) and to be better than the American system—the all our Australian majors are in that select banks in America have got at least five company. Even our smallest major has a regulators that I can think of. John Laker can market capitalisation that is now higher than probably think of more. There’s the Federal Citibank, Deutsche Bank or Barclays. And Reserve Board, the Comptroller of the where in other countries the governments are Currency, there’s a special regulator that just putting taxpayers’ money into their loss- regulated Fannie and Freddie, there’s the making banks, our banks are profitable and Federal Deposit Insurance Corporation, and are paying the Government for the hire of its there’s a whole lot of state regulators. How AAA sovereign rating. could anyone feel accountable in a situation where you were just one of five organisations Now, I don’t wish to imply that Australian that were responsible for something? banks will emerge completely unscathed Anyhow, I don’t want to go any further down from this crisis—they won’t. Well, they that path. haven’t, but the contrast between them and most of their overseas counterparts is This presentation sounds like a defence of enormous. the four pillars policy, something that I was always reluctant to do in my former role. In At first I thought this was a unique story some sense it is, although I’m not arguing about Australia, but there is one other that it should be set in concrete forever more. important OECD country that has also not I can conceive of circumstances where there had to draw on the taxpayer to keep its would be a case to relax it. All I’m saying is banks afloat. I refer here to Canada. It still that, with the benefit of hindsight, we should has the same five major banks that it had 20 recognise that it has served Australia well years ago because in 1998, faced with two over the past two decades. We may have The crisis: causes, consequences and lessons for the future. The Australian perspective 45

foregone some gains during the high savings of Europeans provided their expansionary phase but we have avoided banks with deposit growth well in excess of a potential disaster during the present their banks’ profitable domestic lending international crisis. opportunities. Now, most people would characterise this as a very secure position for There’s another important and overlooked a bank to be in, but we now know that so reason for the relative stability of our banking many European banks came to grief. system and, like the four pillars, it has worked in a way that defied conventional Why was it so? The answer is that, if you views. For many years Australian banks have have not got good domestic lending not been able to fully fund their domestic opportunities to people and firms that you lending by raising domestic deposits. know, you will make loans to foreigners that Instead, they have relied on borrowing you do not know much about. In this way, offshore on foreign currency and swapping it European banks bought huge quantities of back into Australian dollars. They were very subprime loans, CDOs (collateralised debt careful to avoid the foreign currency risk, obligations), synthetic CDOs and other which they did. But they still had a funding dubious securitised assets that are now risk, if the cost of funds rose or the derided as ‘toxic waste’. availability of funds dried up. I, and another senior banker of my close Many observers, including the IMF, pointed acquaintance, just said the same thing an out this vulnerability and banks conducted hour ago. I don’t know whether you noticed it, stress tests to see how they could handle but Mike Smith is of this view as well as me, various crisis scenarios. Now, this was a and I think so is Ric Battellino. We have no vulnerability, it still is a vulnerability; I’m not doubt that, if Australian bankers had found saying this is a false vulnerability. It was themselves with a surplus of domestic something that anyone who looked at the deposits, they also would have acquired a lot Australian banking system would see as a of dubious foreign assets just as their potential cause of problems. European counterparts did, so we were saved. We didn’t have the wherewithal to buy Fortunately in this crisis, we have just been these things. through a real world test that was more severe than the ones I have seen in the As well as that, of course, we had a buoyant theoretical stress tests, and the banks have domestic economy that provided so many come through in good shape. It wasn’t easy local lending opportunities. Of course, our and there were plenty of nervous bankers in interest rates never got as low as those in the the three months from mid-September when US or Europe. access to offshore term funds closed completely, but the crisis was overcome with Finally, and I think this is quite important, our the help of the Government’s AAA sovereign banks’ dependence on offshore borrowing rating. So as I said there was vulnerability but made them determined to keep their high we overcame it. credit rating, and so they were aware that they couldn’t take some of the risk that others Now, consider the opposite situation that the were taking because they would jeopardise European banks found themselves in. The 46 Australian Securities and Investments Commission | ASIC Summer School 2009

their credit rating and therefore their So, my conclusion is that there were two borrowing costs would rise. additional surprising answers. First, a policy designed to increase competition—the four That’s when I try to answer the question of pillars policy—actually reduced it to a why our banks did not get involved in the sustainable level and thus prevented our follies of their US and European banks from moving too far in the risky counterparts. I start by observing our sound direction. Second, vulnerability in the funding economy, our higher interest rates and our model of Australian banks prevented them well-functioning regulatory framework, but from adopting practices that, in other more that’s really not enough, I don’t think, to conventional banking models, turned out to explain it. To explain why we avoided a have disastrous consequences. banking crisis of this magnitude when almost no other OECD country did, you need more. Thank you, very much.

Panel discussion Moderator Mr Tony D’Aloisio, Chairman, ASIC Mr Ric Battellino, Deputy Governor, Reserve Bank of Australia Ms Belinda Gibson, Commissioner, ASIC Dr David Gruen, Executive Director, Macroeconomic Group, The Treasury Dr John Laker AO, Chairman, Australian Prudential Regulation Authority Mr Graeme Samuel AO, Chairman, Australian Competition and Consumer Commission

TONY D’ALOISIO perspective on the thesis advanced by Ian Thank you, Ian. I think that neatly leads us and his thoughts on what’s differentiated into the panel discussion, which I’m going to Australia. Are we faring better and why is that break up essentially into two parts. so?

In the first part, we’re going to build on Ian’s DAVID GRUEN presentation. In the second part, we’re going Okay, thanks very much. Well, it’s a huge to move more to the issues that do confront topic this and what people ultimately think Australia and do confront us going forward are the core causes of the crisis is somewhat and how regulators and others are dealing of a Rorschach test. A Rorschach test is with those. where you put a bunch of ink dots on a piece of paper and you ask people what those ink So to just kick off and get the response from dots mean and you learn from that what their the panel to the thesis that Ian has put deep inner thoughts are. forward— This is a sufficiently complicated crisis that I’ll leave Graeme Samuel last to comment on we have had a variety of causes identified it because I’m sure Graeme will also want to depending on one’s predilections, starting talk about whether the four pillars policy did from government support in the United really make all that much difference given the States for the idea that you should extend way the Trade Practices Act works on home loans to people at the bottom end of mergers. I want to start with David to get his the income distribution, and seeing that as The crisis: causes, consequences and lessons for the future. The Australian perspective 47

the ultimate cause. But I think most people to go back to them and say, ‘We paid you have identified poor risk management several million dollars along the way and practices broadly in the financial system, we’d like it back now that you’ve blown the exacerbated by regulation that didn’t hold whole system up’. I think that’s a big issue those things in check. and I think I will have the opportunity to say many more things, but that was my reaction. I think what Ian’s saying fits in with this. As I took his comments, he was saying that the TONY D’ALOISIO regulations as we currently have them for the In short, you don’t buy the argument that the financial system are not sufficient to stop four pillars policy really made all that much what is essentially very damaging short-term difference? behaviour by financial institutions. As I understood him, he’s making the argument DAVID GRUEN that four pillars stopped all sorts of behaviour I’m not saying that. I’m saying, as I on the part of Australian banks. In a sense it understand Ian’s argument, that it seems to gave them a longer-term perspective than me he’s making the argument that it was a they would otherwise have had. If they were mechanism for, if you like, lengthening the constantly worried about being taken over, horizon of bankers to look at the things they they would have been more focused on, if needed to look at and not make them focus you like, short-term performance and less on short-term PE ratios that stopped them focused on things that would keep their credit from being taken over by another bank. He rating up. This is a big theme of the whole may well be right, that that was an important crisis in the following sense— constraint on that sort of behaviour.

I think we have found that leaving the TONY D’ALOISIO shadow banking system unregulated doesn’t Ric, what’s your view from the perspective of work. It’s just too interconnected with the rest the RBA (Reserve Bank of Australia) in terms of the system to leave it unregulated, and of the thesis that Ian’s putting forward? what we’re trying to find our way towards is RIC BATTELLINO a system of regulation that stops short-term Well, I agree with Ian. I think Ian’s comments behaviour, short-termism on the part of have been quite insightful. The international financial markets, and it seems to me that’s context in which banks have been operating kind of a broader way in which you can over the past decade or so is one in which interpret Ian’s remarks. there’s been a surplus of capital in the world, Certainly, I would agree with that as one of and the banks from the capital exporting the core problems. The incentive structures countries have been under constant pressure are such as to encourage people to take to find ways to invest that capital. So it’s not risks that might have 20-year consequences, surprising that they’re the banks that have which they don’t have to worry about. If a got into trouble. It’s the European banks that financial institution makes good profits for find themselves in this very difficult position 19 years then blows the system up in the at the moment. 20th year, the people who made those I don’t think we should be too harsh on the decisions along the way won’t be there to American financial system. I mean they did pick up the pieces. We do not have systems what they always did best; they are very 48 Australian Securities and Investments Commission | ASIC Summer School 2009

innovative and very dynamic. They could see Anyway, the banks here have had plenty of there was money everywhere in the world opportunities to make money and expand that needed to find a home. The investment their balance sheets so they haven’t had to banks in the US have always been at the look around the world and engage in more leading edge of finding ways to use money, risky propositions. and they found a way to use it. It wasn’t a very good way to use it. TONY D’ALOISIO John, your perspective? TONY D’ALOISIO Does that mean that we’re less innovative JOHN LAKER and losing money? What’s the corporate Thank you, Tony. Well, I had the privilege of culture here? Why weren’t those issues working for Ian for many years and I always pursued here? liked his speeches. Now he actually is a Board Director of an organisation that I RIC BATTELLINO supervise, I don’t have to like his speeches Well, there are two issues. First of all, the any more, but I do! I like Ian’s insights in economy itself was expanding strongly particular because they help to address a throughout that period. The banks chasing conundrum that’s come out of the earlier profitable lending opportunities in Australia discussion about the role of regulation— could grow their balance sheets by 15% whether it’s causal or accommodative. a year and maintain reasonable interest margins without having to take on new In the global banking system, the ground rules additional risks around the world, or even are the Basel framework. It is important to note here in Australia. that they did not apply to the US investment banks as we knew them, but they applied with Now, we did see elements of competition limited national discretion across the globe. here coming from new players—mortgage And the puzzle that hasn’t really been originators, regional banks. We all applaud addressed is why, if we all operated within that competition because we think competition is same set of global rules, were countries like good and we tend to think of competition as Canada largely untouched by the global cutting prices for borrowers, but the truth is financial crisis and Australia as well? Why, a lot of competition comes from cutting credit within countries that have been badly scarred, standards. do some banks continue to do well, and why even in our own case (where the financial If you look around at the problems we have system has coped better than most other with housing loans in Australia, they haven’t countries) did some of our institutions still dip come out of the major banks. They have their toes into the more complex instruments? come out of those very institutions that we all applauded as providing good deals for I think we need to step back from simply households. If you look at Southwest saying, ‘it’s got to be regulation’, to look for Sydney, where all these mortgages are more subtle insights and that’s what Ian has getting into trouble, they’ve basically come brought to the discussion. I find the argument out of mortgage originators and regional about the four pillars policy quite a banks, so competition is a two-edged sword. persuasive one when it’s put in those terms and it’s backed up by the sense that in The crisis: causes, consequences and lessons for the future. The Australian perspective 49

executive remuneration arrangements in these markets, although that temptation Australia in the regulated sector in particular, wasn’t particularly strong. I think the we didn’t see the excesses that have been domestic focus and the opportunities in given so much publicity offshore. This is not Australia to grow very profitable businesses to say that the public in Australia still can’t is one of the major reasons for that and understand the absolute levels of bank institutions have done so within the comfort salaries, but they have not provoked the sort of not being taken out overnight by one of of outrage that we have seen in other their competitors. markets. TONY D’ALOISIO When we have looked at it in APRA, the Belinda? other factor on which we have placed quite a bit of weight was a point that Ric has made BELINDA GIBSON as well. There were substantial domestic I’d further advance the argument put by opportunities available in any event and our John—four pillars of itself gives the argument banks, if you look at their balance sheets some resonance. But I’d like to just talk a now, they still have virtually half of their total little bit about the model here in Australia and portfolios in housing lending. That wasn’t the our market with the opportunities, the case 20 years ago, 30 years ago. They were domestic opportunities, for expenditure. We mainly corporate lenders then. So there have have not had the need to derive the been tremendous opportunities in housing sophisticated models that seem to have been leading up to the housing market boom in very prominent in the downfall in the US and 2003. When the boom came off, the in Europe. corporate sector had the capacity to borrow There has been less need and less and a lot of activity went into growing the opportunity to develop complex instruments corporate books. that really just slice and dice risk. People There was a lot of business to be won at perhaps deluded themselves into thinking home, so the orientation has been largely that they had completely got risk put away. domestic. There was less need to do that and less opportunity to do that in our markets, which I think that’s probably a factor in why only two I think is another circumstance that has of our major banks—and it’s all on the public assisted our banks. There are also fewer record, I’m not giving away any secrets dominant, complex conglomerates here than here—two of our major banks did have some elsewhere and it is those conglomerates and limited exposures to CDO and CDS (credit the pooling of risk, the contagion of risk that default swap) markets. is more of a feature in these markets.

Why is that? One of the reasons would be TONY D’ALOISIO they are probably the two most outward- Graeme—section 50 of the Trade Practices looking of our institutions, just by their history Act and the four pillars policy have saved us? and by their offshore exposures. Something obviously is going on within institutions and GRAEME SAMUEL within Boards that tempt some institutions but When I heard Ian make these comments not others into going offshore, going into I had a bit of a chuckle because I thought there’s a little bit of sleight of hand going on 50 Australian Securities and Investments Commission | ASIC Summer School 2009

here with the use of the word ‘competition’. responses that we get to urgings to pass on Because what Ian actually (in a sense) interest rate cuts. It is quite amusing that merged into one proposition was competition some of the bank executives come out between the banks and competition for before we do it and say, ‘Yes, we will reduce corporate control, and, of course, they’re two by .8 or reduce by 1%’. It all happens entirely different concepts. I think, Ian, you relatively in unison. That’s not to suggest conveniently sort of merged the two, so let there’s any cartel behaviour, it’s just the way me try and put things into, if I can, the the workable competition or comfortable competition regulator’s sense. oligopolies tend to work.

Four pillars is a consequence of workable So we have got section 50, we have got four competition amongst the banks, or less than pillars, but what we essentially have is intense or aggressive competition. It’s not the something that’s developed over many years cause of it. In fact, four pillars in a sense is a in an economy of this size and that is four big bit of a supernumerary; in one sense, banks that compete against each other because we have less than intense or reasonably comfortably. They don’t go into aggressive competition between the banks. aggressive competition and I doubt that in the absence of four pillars you’d be able to Now, in previous inquiries we have had of see any mergers anyway because of the recent times into groceries and petrol, we operation of section 50 of the Trade have talked about ‘comfortable oligopolies’ Practices Act. and ‘workable competition’. I know I’ll get a headline if I say exactly the same thing about The element that Ian didn’t cover that I’m a the banks, but the reality is that what we bit interested in, is to hear more commentary have in Australia is probably workable on the role of the investment banks, and competition or a comfortable oligopoly. some of the bigger ones. I’m thinking of the Macquaries and the Babcock & Browns, Whether it’s the four pillars or section 50 of which in a sense had some of the pressures the Trade Practices Act, I don’t think it really that were outside four pillars but also some of matters. I am reminded of the words of Mr the competitive pressures, and we have seen Kerrigan in The Castle: ‘Tell ‘em they’re what’s happened to those over recent times. dreaming.’ TONY D’ALOISIO If people were to come to us with a merger Thanks, Graeme. Ian, just coming back to of two of the four pillars, I’d probably say, you—by implication you’ve not dismissed, or ‘Tell ‘em they’re dreaming.’ That’s the nature at least you’ve put into second lane, some of of the way competition works. What the four the other reasons that have been talked pillars approach does is put that decision about as really pointing out the difference as making as a layer on top of the decision to why Australia has to date fared better, and making of the ACCC and into the hands of it looks like it will be faring better as the crisis our political masters. continues to unfold.

So we have workable or manageable One reason that came up in the previous competition, but that’s about the level of it in section was the corporate culture and the our banking sector. That’s probably best issues in Australia and the way those evidenced, I think, Tony, by some of the The crisis: causes, consequences and lessons for the future. The Australian perspective 51

corporates and that corporate culture I think it is possible to have too much works—perhaps they’re more risk averse competition in financial services. I find it hard than our counterparts in the United States. to say that for manufacturing or something I’d like to cover that, then I’d like to cover a like that. But for financial services, where number of other possible reasons as part of really what you’re trading are promises— this discussion before opening it up to the promises and forecasts and guesses and floor. guesses about what’s going to happen—it is possible to have too much. What’s your view about corporate culture in Australia? I think the US, certainly the US investment banks, had it. It wasn’t just the fear of being IAN MACFARLANE taken over. I think the performance pay Well, first of all, Graeme, I’m pleased to hear structure within the institutions also your presentation, it makes me even more encouraged that. There are a whole lot of comfortable because what it says is, even if things, but deep down I think our culture was you didn’t have four pillars, we have got superior because we didn’t have excess Graeme Samuel who would make sure that competition. We had probably workable we still only had sensible workable competition. competition in Australia. I think my analysis of competition is actually very similar to yours TONY D’ALOISIO and what we’re just talking about—was it four Could I get other panel members’ views on pillars or was it section 50 of the Trade that—that is, that the culture is driven by Practices Act? They’re both working in the competition? What about the notion that the same direction, so that’s extremely good. corporate culture is driven by simply the ethics, the business approach that As to the issue of corporate culture, I think corporates have in Australia, compared to it’s related. If you were worried next week— overseas? particularly if you were in New York or in London, but it’s also true in parts of Europe— BELINDA GIBSON that you were going to be taken over by your Another item of corporate culture that we nearest competitor, that would exert a degree touched on this morning is the whole of pressure on you that’s much more intense question of appetite for risk and ability to than the normal business about whether your assess risk and how you manage it within the competitor is going to make a loan that you corporation. I think maybe that it is a product were hoping to make. of Australia being smaller. All of the major Australian banks have had their moment of I think it does induce this obsession with crisis and moment of examination over the short-term profitability. We have got to be past 10–20 years and those have been the more profitable than the next one, we have bet the homestead-type events. It’s much got to have a higher rate of return on equity, harder for offshore institutions to have had we have got to have a higher PE ratio, and in the homestead-type events. that way survive—in fact, possibly being a predator ourselves, because if we don’t we’re I think Australian culture still has some better swallowed up and we disappear. capacity to assess risk and measure it. There have been some issues in pricing of it. There 52 Australian Securities and Investments Commission | ASIC Summer School 2009

have certainly been some issues in TONY D’ALOISIO disclosure. But it is another feature, I think, David? of the Australian climate that there is greater thought given to that. DAVID GRUEN I think I’m just going to be covering ground TONY D’ALOISIO that other people covered, but I think the John, corporate culture? experience of the early 90s for the major banks was a scarifying experience that they JOHN LAKER don’t want to go anywhere near again. And it We in APRA have spent quite a lot of time in led to very substantial improvements in risk the last few years focusing on governance management and an understanding even and ‘fit and proper’, which came up in the that it improved their risk management earlier discussion. We had some quite practices and just was a powerful reminder animated exchanges with industry and a that, even if you’ve had a long period of range of the associations about what we strong growth, it doesn’t last forever. were seeking to do. TONY D’ALOISIO Put simply, what we wanted to do was to lift Ric? the standard of governance in our regulated industries as a whole to the standards of the RIC BATTELLINO best performing institutions we already had, I’m a bit reluctant to start congratulating and they tended to be the major institutions, ourselves that somehow we’re doing things the major banks. The governance better than the rest of the world because I frameworks we put in place didn’t require don’t think we are. Most of the risk many changes at all for the top dozen or so management practices here are imported institutions. It did mean that some of the from North America. smaller institutions, which had slipped behind or which never had those high standards, did Look, the thing is, companies and banks have to improve governance, look for more around the world were under intense independence on the Board. pressure from investors, pension funds etc. to provide very high rates of return—20% We felt that we were well served in Australia return on equity. It just so happened our by the standards of governance in our major banks could do that without taking on a lot of institutions, but every now and then, a wake risk. Now, whether that’s because of four up call comes along that just sharpens their pillars or whether it’s because the economy focus. One was the National Australia Bank’s was strong, who knows? foreign currency options problem. Every Board of every major institution without us A combination of all those things helped. pressing went straight in and said, ‘Can it They were able to provide the returns that happen here? If not, why not?’ That sort of investors wanted without engaging in risky probing has been going on. Even though practices. complacency was an issue all through this TONY D’ALOISIO decade, I still think there were enough It’s worthwhile exploring what the reasons reminders that good times come to an end are because it’s really what part of the for Boards to stay focused. lessons for the future are. Just saying, it’s all The crisis: causes, consequences and lessons for the future. The Australian perspective 53

those factors’—we’re really trying to hone in Now, if that were the case, then actually it’s on those that matter. an argument, Ian, for getting rid of four pillars and getting rid of section 50 of the Trade RIC BATTELLINO Practices Act and consolidating more and But the point is, realistically, the fund more so you have even less competition. managers were asking too much from the And you know you could earn some great world financial sector and the banks tried to returns out of being almost a monopolist, provide those returns by taking on more and which is the last thing I think we want to see. more risk. That’s what happened in North America, that’s what happened in Asia. I go back to Ian’s first statement in relation to That’s really what was going on, and if our this, where he said that what we had was banks couldn’t have provided those returns, intense competition amongst poorly they would have taken on more risk. You see regulated banks. This is happening it here—the smaller banks couldn’t provide internationally. And it strikes me that I those returns, and they were taking on more thought the most important words there were risk. not the intense competition but the poor regulation in the international scene. TONY D’ALOISIO Graeme? It seemed to me, that in Australia we had three things that were operating in our GRAEME SAMUEL favour. One was very good regulation coming You wouldn’t be surprised if I started to from the two regulators, APRA and the hesitate a bit at Ian’s proposition that too Reserve Bank. And interestingly for those much competition is bad and is dangerous. who are over in Davos—I wasn’t in I well understand you’re coming from some Switzerland, but I had some reports back — of the directorships you’ve now got— the Australian regulatory model was Woolworths, for example—that you’d want acknowledged as being one of the best in the to put that proposition to a competition developed nations in the world, as far as the regulator. financial system was concerned.

JOHN LAKER We had a very diligent regulator in APRA, I think he said financial services. who resisted all the pushes that were coming from various segments of the finance sector GRAEME SAMUEL to back off and let them have their own way, To be fair he did say financial services, but and saying that APRA was too prescriptive in the problem I’ve got with it is: if you say that their regulation. John and his team held the too much competition is bad, then the line and said, ‘No, that’s just not what we’re corollary of that is that, the less and less going to do. We’re not going to succumb to competition we have, the better off we are. that sort of pressure.’ And I think that has a danger, not the least of which is one of the propositions that Then you had, interestingly, the Reserve Ric’s just put, and that is that the banks in Bank coming out there and saying to those in Australia with the workable competition were the financial sector, ‘Guys, you are being actually able to earn good returns without dumb. Some of the real estate lending that is having to take some of the risks that were going on is wrong. There is a real estate taken elsewhere. 54 Australian Securities and Investments Commission | ASIC Summer School 2009

bubble that’s occurring.’ And many would say significant economies in the end had resilient that some of the comments that Ian and banking systems—they were Canada and subsequently Glen made actually helped us Australia. So that’s why I’ve given emphasis subside that bubble a bit. Yes, to the distress to the sort of workable competition, rather of some of those that have been investing, than intense competition, that you saw but ultimately this managed to subside it so elsewhere. we didn’t end up with, at that stage anyway, a lot of the problems that have been That’s part of it and the other part of it is the discovered elsewhere in the world, and Europeans. I think they got into trouble, for particularly the UK and the US. the second argument, because they had all these deposits and they had to find some TONY D’ALOISIO assets to put them in and so they put them in Thanks. Just a final comment, Ian, before the ones that we now call ‘toxic’. So I think asking questions from the floor on the between those two you can explain why it regulatory model—do you have a view about was only Australia and Canada that came the effectiveness of our regulatory model? through in reasonable shape.

IAN MACFARLANE TONY D’ALOISIO I think we have a good regulatory model, but Before I move to part two, where we will look I think a lot of other countries did too—for at the issues that do confront us— example, the Dutch. notwithstanding that we may be performing better—are there questions from the floor on I know a lot of people in the FSA in London, the differences and the reasons for those I’m very impressed by them. A lot of people differences? I’ll take two or three questions had a good regulatory model but only two and then move to part two.

Questions from the audience (names withheld)

Question 1 say in any way they were responsible for I’m interested in the role that the media may causing the situation we’re now in. have played in driving lack of confidence within markets and within consumers TONY D’ALOISIO generally. I’ll be interested in the views of Graeme? the panel on that. GRAEME SAMUEL

TONY D’ALOISIO I won’t mention the names of the two The question is the role of media in market newspaper organisations involved, but just confidence. Ian? last week on my Blackberry at a certain time in the afternoon I received two email headlines. IAN MACFARLANE Headline number one was this: ‘Growth Well, the media didn’t cause it, but the media statistics defy gloom’. Then the rest of the obviously exaggerate and prolong it. I’m sure article talked about the growth statistics in it’s always the case, but I don’t think we can terms of investment in the December quarter that defied the gloom and suggested that The crisis: causes, consequences and lessons for the future. The Australian perspective 55

there might even be some positive GDP BELINDA GIBSON growth. This is where I say this is my personal view and not that of ASIC. My own view is that our The other newspaper headline that came law is fine in that regard. It is a bit like the exactly three minutes later said this: ‘5,000 argument we have on corporate social jobs lost, more to come’. The 5,000 jobs responsibility. The application of the law and statistic took in the Pacific Brand statistic and the principles to act in the best interests of the Lend Lease statistic of 1700. What it the company—to act for proper purpose and failed to mention was that, of the Lend Lease so on—can usually be worked, or would 1700, only 349 actually related to Australia, always be worked, to have a sustainable the rest were overseas. Now, you make your point of view, a longer-term point of view. own judgement about the responsibility of either of those headlines and the articles that The only time where there is a crunch is a followed. takeover where things become much more ‘pointy’, and that one must deal with in the TONY D’ALOISIO short-term. That’s not to say that there isn’t Any other comments from the panel? Next much more room for discussion and question? education amongst the management community and the director community about Question 2 how it is to be applied—and sustainability is I just wanted to pick up this theme of always a relevant criterion to advocate. procyclicality and some of the issues surrounding managed and less intense TONY D’ALOISIO competition—and wondering whether there’s Other views? Ian, did you want to— some learnings that might lead us to some corporate law reform at the level of directors’ IAN MACFARLANE duties to perhaps put into this complex If we’re talking about procyclicality, I agree balancing act. with John: it is just an enormous problem. It pervades the whole economy. Accounting And to examine the issue of having some laws are procyclical, tax laws are procyclical, formal duty of sustainability at the level of banking regulation is procyclical. The most directors’ duties to perhaps provide some procyclical of all are the rating agencies, and sort of bulwark against pressures for short- human nature is procyclical. termism in the conduct of corporate activities. It is just very difficult to fight against all those Now, I understand that there’s a wealth of things that—when times are good, people danger in that proposition as well, but I think they’re incredibly good; when times are wonder whether competition became so bad, they panic—and a lot of the institutions dominant, became a plaything of the that are designed to protect us actually made investment banking sector as an end in itself, bad things look worse and they made good and whether we perhaps have lost some things look better. balance that may need to be restored at the level of directors’ duties. It pervades the whole economy but particularly financial markets, absolutely— TONY D’ALOISIO they’re just riddled with some institutions that Belinda, would you like to— 56 Australian Securities and Investments Commission | ASIC Summer School 2009

make the good things look better and the bad well before the crisis started, thought it things look worse. needed to be refreshed. So we started to work with industry on what a more TONY D’ALOISIO comprehensive, and in a sense a more Is there another question from the floor? modern, liquidity risk management framework would look like, emphasising the Question 3 role of stress tests, etc. Then we landed right There seems to be some consensus on the in the middle of this huge real-world stress panel that Australia has some capacity to test. We have got a lot to learn and are still focus on the medium and long-term, which learning about what is good practice in I agree with, but I’m not entirely sure I’m liquidity management and certainly what is confident that our government is focused on bad practice. We’re distilling all of that that yet. I just wondered if I could have the information now and we will come back to views of the panel about what you would like industry with a new framework that will be to see as medium to longer-term initiatives? quite timely. TONY D’ALOISIO We have been asked by the Prime Minister David? to get involved in the difficult question of DAVID GRUEN executive remuneration, which goes to the I don’t think I’m going to answer that issue of medium and longer-term incentives question. for Boards. What we will do is develop, in consultation, a set of principles for good GRAEME SAMUEL practice and they will be about how one My standard response is it’s just a matter of raises the horizons of executives, through policy and that’s for government. the incentives structure, to look beyond next year’s reporting or next month’s reporting TONY D’ALOISIO season. That work is underway currently. Okay, I’m going to finish off with a couple of questions for the panel. Is there any part of One topic that came up in Adrian’s our regulatory regime that may need some presentation is non-operating holding attention over the next few years? companies—that’s a very complex area. We allow that framework in Australia. At the top There are a number of initiatives that are is a non-operating holding company that has going on internationally. Is there a key one to have enough capital. There has to be that stands out for us, that we think from enough capital within the group to sustain the a regulatory point of view we should get whole of the group’s operations. That is a engaged in over the next couple of years? very complex area and, again, that’s John, do you want to— something we will consult on with industry. JOHN LAKER That’s enough to keep us off the streets for Well, Tony, I also mentioned procyclicality— a while, Tony. that is a global initiative. Our immediate TONY D’ALOISIO priorities, if I look at our current policy Belinda? agenda, clearly involve liquidity risk management. We had a framework in place in this area for some years. We ourselves, The crisis: causes, consequences and lessons for the future. The Australian perspective 57

BELINDA GIBSON financial system that in such a world doesn’t I think an area that requires looking at is our blow up. whole selling disclosure regime, particularly to the retail investors, but also in the RIC BATTELLINO wholesale end of the market. I think history shows that’s impossible to do.

The essence of this problem really is, if I TONY D’ALOISIO could paraphrase Lord Turner, ‘This is a self- That leads me to a final question: what is the fulfilling cycle, falling risk aversion and rising one thing you would want the G20 to really irrational exuberance’. It is all about people look at and deal with? We have got the G20 not understanding the market, not coming up in April and the last G20 meeting understanding what they’re dealing with and had, I think, something like 47 recommend- not understanding how to deal with it. And ations for change. If you could actually give a that means we must get better at explaining message to the G20 to concentrate on one to people what it is that they are dealing with thing, and I’ll extend this question to the other in terms they can understand, other than in panel members as well, what is the one thing 200-page books. you would want the G20 to really look at and deal with? TONY D’ALOISIO Anything else from your end, Ric or Graeme, IAN MACFARLANE in terms of regulatory issues that need I think the biggest thing for them is this global attention. imbalance. I think if you go behind where we got to—Ric’s right to say world interest rates RIC BATTELLINO were too low given the strength of the world Well, I think the big issue for the central economy. They were too low. How did they banks of the world is that the core of this get to be too low? And it goes back to the problem was very low global interest rates of global imbalance. five years ago, and the question is: what caused those, was it a policy mistake or was It goes back, in my view, to a number of it the global imbalance? These issues need countries running very large current account to be resolved, so it’s going to take a lot of surpluses, which they had to invest study to see this problem resolved. somewhere. They invested them in the US and so we saw this period of very low interest DAVID GRUEN rates. I could go into it in a lot of detail but we Can I just add a comment on that? One haven’t got time at the moment. would hope that one could have a global financial system that can cope with low I think we have to find a way of getting the interest rates. I mean there might be times surplus countries to spend a lot more money, when you need to have low interest rates, and to consume a lot more. You can’t expect even for extended periods and we can’t, as a the United States to get us out of this, they’ve small economy, determine the global got no hope of getting us out of it, it has to be saving/investment balance—but at times that the surplus countries, so that’s what I would saving/investment balance may be consistent be pushing for as hard as I could at the G20 with low real interest rates for some extended meeting, which I, of course, won’t be period. You would hope you could design a 58 Australian Securities and Investments Commission | ASIC Summer School 2009

attending. I think I’m going to a seminar or TONY D’ALOISIO something in a couple of day’s time Thank you. organised by the British Government to make suggestions for the G20 meeting. The objective we’d set for this session was to provide a better understanding of the TONY D’ALOISIO differences between the Australian and the Any final comment from any of the members international events and really to try and of the panel on that? John? explain or provide the reasons for that difference and then to move on and look at JOHN LAKER some of the issues that we need to continue Ian’s right to focus on these major issues. to deal with as we work our way through the I just hope that what comes out of some of crisis. these global initiatives is pressure on the US authorities to put in place a much more You’ll agree with me that the speaker and coherent regulatory structure in the US, panellists really hit those issues and hit those because while it remains as Byzantine as it issues very clearly and very succinctly and is, and with all the vested interests, we’re just please join me in thanking them for their going to perpetuate this problem of weak US contribution this morning. banks. What went wrong: lessons from the boardroom 59

MONDAY What went wrong and what we’ve learned What went wrong: lessons from the boardroom

Dr John Stuckey, Senior Advisor, McKinsey & Company, and Chair, ASIC’s External Advisory Panel

Opening remarks by Mr Peter Thompson, ABC television and radio broadcaster

PETER THOMPSON To counter this directors and managers first Good evening, I’m Peter Thompson and it’s need to recognise their own fallibility and nice to be with you. At the dinner Tony then build a defence mechanism to help D’Aloisio said to me, when the Summer counter it.’ Many questions arise and we will School theme was first thought of, it was get to some of these, if not all of them, in going to be called ‘Post Financial Crisis: The tonight’s discussion. issues that matter’. And it was realised the Executive remuneration, which has been word ‘post’ would have to be removed. mentioned more than once today—and as the Today many people in this room have been politicians close in on this emotional issue—how grappling with the issues of the causes, much is too much, especially in the financial consequences and lessons for the future of sector, where the repackaging and churning of what went wrong. And as I sat in on the debt and the pressure for short-term returns has session late this morning, I realised that what been one of the features that has been being at the Summer School can do—but underlying the crisis? Risk management—were what reading the press or reading worthy Boards adequate to the task of hedging against journals can’t do—is give you a sense of a once in a generation souring of markets? Did what’s between the lines, what are the they miss the big picture? Accountability—will nuances that you can’t pick up via the written the crisis create a new slate of corporate record. regulation? Transparency—will Boards seek to be more knowing about opaque financial Tonight we shift our focus and perspective to instruments? How do Boards restore the the Boardroom, the engine room of corporate market’s trust? What do Boards need to look at governance, to explore some of the many for now, given that the slump is likely to be questions being asked by those sitting on the protracted? What good will come of this crisis? inside and by those of us standing outside looking in. I flicked through a recent edition Well, our conversation tonight is divided into of the Company Director journal and there’s two parts. In a moment, we will hear from Dr a sage comment by John M Green, who is a John Stuckey. Then after John speaks, we regular writer, lawyer, who said: ‘We inhabit hear from our panel: David Hoare, Catherine a world of imperfect information, yet often the Livingstone, Belinda Hutchinson and David market assumes God-like stature for CEOs Murray. and Boards and ego can encourage some of Please welcome John Stuckey. us to relish the glory, until things go wrong. 60 Australian Securities and Investments Commission | ASIC Summer School 2009

JOHN STUCKEY bit of that and when we get into the discussion Today I sat in on various discussion sessions panel we will particularly focus on that. But at the Summer School and I was listening to what I’m actually going to talk about is from the people with lots of thoughts about what went perspective of corporate Australia: what do we wrong, in particular lots of thoughts about want to see happen differently, if at all, in the what we should do differently in the future. markets out there? And it reminded me of my favourite John Lennon lyric which runs: ‘Life is what With respect to regulation, I should happens to you while you’re busy making emphasise that these are my own personal other plans’. views. Even though I have a role within ASIC these days, I can assure you Tony has not The reason I thought of that was, while had anything to do with my speech, so we have been sitting in the beautiful air- anything I say is my view and not ASIC’s. conditioned comfort of the Hilton talking about how we can fix the system, the Let me start off on the first point, which is that markets out there have been doing the heavy we should principally rely upon markets to lifting that’s going to be required to get us sort out the imbalances that are in the back into some sort of equilibrium. system now. The initial thing I would say in support of this is that, as far as I can judge, I guess the major point I want to make the Australian securities markets have tonight is that this is a market economy, and performed remarkably well since the thank goodness it is. I want to make a case beginning of the subprime crisis. that we should continue to rely largely upon markets—and when I say markets I don’t just We don’t like what’s happened to the prices mean securities markets, though I will on a number of these markets, but as far as I concentrate on them. I also mean markets can figure out they’ve actually performed ranging from securities to real estate to really well. cement, whatever you like. In fact, even the One difficulty has arisen though, even if for market for executive remuneration, which I’ll very good reasons. The Australian come back to later. Government came in and guaranteed There are three particular points I want to deposits in the banks. That’s actually make tonight. Firstly, we should leave most distorted the savings market—broadly of the adjustment burden up to markets. defined—and, as a result, a lot of other That’s the first point. The second point: products have actually really, really suffered nonetheless there probably is some fiddling because no one trusts them, as they’re not we need to do to regulations and I’ll talk a government-guaranteed. Even the financial little bit about that. Finally I will talk about one advisory industry is hurting pretty badly. You particular market, which maybe hasn’t can’t charge 2% for very long if you’re telling worked quite so well, and that’s the market people to get into term deposits, so it’s a little for executive remuneration, which I think is bit of a worry for them as well. So there’s one of those hot topics that’s almost upon us. been some distortions caused by that particular regulation, but we all know why the I’m supposed to be talking about lessons from Government did it. the boardroom, and in fact there will be a little What went wrong: lessons from the boardroom 61

The markets are performing pretty well it sort the wheat from the chaff amongst the seems to me. They are doing a pretty good hedge funds very, very quickly, and there is job of sorting what you might describe as the evidence that it’s happening right now. ‘wheat’ from the ‘chaff’ right now. For one thing, not many Australian companies have Furthermore, private equity is too—it’s actually gone bust, very few, in fact. The actually quite a legitimate and valuable ones that did fail had a business model that approach, as I think hedge funds are, by the had them sailing pretty close to the breeze way—but as usual in the winnowing process anyway. This has happened in Australia in in the market system, when you take high the past—starting from the 1961 recession, risk plays you know a fair few of them will fall a few companies went to the wall, usually over and that’s exactly what’s happening, they had a fair bit of property assets and they and I think that’s absolutely fine. had a fair bit of debt, those were the most For example, if you look at some of the common themes. And when you get widened private equity deals such as some of the credit spreads, highly leveraged companies media deals that were done in Australia, they have trouble, they go broke and that’s the are looking pretty ordinary at this particular way the system works. Frankly, as an point in time. observer of the system, I don’t have any problem with that. Imagine if the Qantas deal had gone through. The private equity guys were offering about Secondly, the boom businesses of the last $5.50 a share and, when I looked at the five-plus years—investment banking, private weekend, the Qantas share price was about equity and hedge funds—are absolutely $1.50. So the private equity guys are getting getting sorted out. sorted out as well. If you look at the hedge funds and the private So I think the markets are doing a pretty equity guys, for example, history tells you good job. I didn’t go to the University of very clearly that only about a quarter of them Chicago, by the way, those amongst you who have provided superior performance anyway are economists, so I’m not a ‘dyed in the and the penny is dropping with the market in wool’ marketeer. But I’ve figured out over 30 that respect. The big super funds and years that markets actually do a pretty good pension funds around the world have figured job, though there’s a couple of exceptions in out that the hedge funds didn’t deliver on the recent times. key promise they made to investors. The key promise they made was that they were going In relation to the macroeconomic settings— to deliver a return that was not correlated to monetary policy and fiscal policy—as an the market. observer, I think the interventions have been absolutely in the right direction. I don’t know Well, as it turned out, we found out last year whether $42 billion is the right number, I that everything was correlated with wouldn’t have a clue and I don’t think anyone everything and everything went down. And, else has either. But I think directionally it’s as you look at the performance of most of the absolutely the right idea—those things are hedge funds, their performance was fairly the right idea. The intervention effectively by ordinary. I’m very confident that the big super government or government agencies in this funds and the big pension funds are going to market has been spot on in my opinion. 62 Australian Securities and Investments Commission | ASIC Summer School 2009

However, I believe the way the market in don’t need any adjustment to regulation. In commercial banking in Australia is heading is fact, there’s been an incredible number of unfortunate. We are very grateful that the calls out there in the media, and speeches banks were highly liquid, had strong balance and so on, about the need for more sheets and that APRA (Australian Prudential regulation, better regulation. A couple of Regulation Authority) had done a good job of examples caught my attention—for example, regulating them, and that they’d found much our own Prime Minister wrote an essay over better things to do at home than go and Christmas about the global financial crisis invest in a whole pile of subprime mortgages and what it means. In that particular essay, and so on, or various products created from the phrase ‘properly regulated markets’, or subprime mortgages. But I am concerned as words very close to that, were used 14 times, an Australian citizen that the commercial and in fact the current global financial crisis banking market is going to come out of this was described as ‘the greatest regulatory period on too good a wicket. If South Africa failure in modern history’. The greatest— has a wicket like the Australian banks are pretty good stuff. So that’s one point. going to be on, then we’re going to lose this test in South Africa for sure. If you want another one, which is more picturesque, it’s the good old topic of short I think the fact that St George was taken over selling. Gerry Harvey of Harvey Norman was by Westpac—I mean good on Westpac—but quoted in the newspapers as saying in I think it’s unfortunate that that happened. around about November—this is of short They were actually providing a little bit of sellers: ‘I would line up short sellers against competition. the wall and shoot them’. That’s an interesting approach, Tony. I don’t know I think it’s unfortunate that most of the foreign whether ASIC wants to adopt that, but I banks seem to have pulled in their activity for thought it was interesting. So there are a lot one reason or another. I think this is going to of people saying we have got to do be the cosiest commercial banking set-up something about this. that we have seen in Australia at least since I’ve been involved. And, as Peter said, I Okay, we need to adjust some regulations, actually consulted with one of these banks but I think the biggest risk is that we’re going for 25 years since 1980 and before that. This to overregulate as a result of this. market is not their fault. They’re doing exactly I think there’s a serious risk that the the rational things they should be doing as Americans will overregulate. The Americans private businesses, but I think from the have a history of reactive regulation ‘after the country’s point of view it’s unfortunate. Of event’. Sort of close the stable door after the course, it’s almost ironic that they’re being horse has bolted. treated as sort of national deities at the time I fear that there will be some of that. when they’re actually setting themselves— and sensibly so, rationally so—setting My view is that regulation is definitely not a themselves up in a very, very nice position panacea. History shows this, and our first into the future. speaker this morning from the OECD gave quite a lot of examples. The fundamental (as Anyway, let me move on to regulation and he put it) exogenous cause of the problem make a few comments. I’m not saying we that we’re in now was in fact a set of What went wrong: lessons from the boardroom 63

interventions by governments or standardised products out there, and to help representatives of governments. inform all buyers and sellers that trade on those markets’. There’s a myth that floats around that governments can remove the vagaries of life Let me elaborate a little. First of all, as an through regulation, whether it’s bushfires or aspiration, I would be suggesting that we financial fires. I think it’s an absolute myth. create more public exchanges for various Government can’t regulate away uncertainty. sorts of securities. Public exchanges—for Life is an uncertain event and I think we have example, the stock market—have worked to learn to live with that as part of becoming a well in the past, and I would like to see efforts little bit mature. made to create more public exchanges. The goal of these exchanges—and I’d make However, I think we can as regulators—I these government entities of one type or shouldn’t say we, I should say you guys as another—would not be to make money, but regulators—can actually do something. I to provide integrity and transparency, to think the way you should think about it is collect, analyse and publish information as follows. about what’s going on in these markets, to You should think about the goal of regulation. foresee problems and to try and use It is actually to make markets work better. information dissemination to subvert those The role of regulation is not to kill them or problems. stop them from working; it’s to make them A good example of the sort of market I have work better. How I think about it is that you in mind is one I’ve learned about recently. go back (as you might expect from an old It is the Canadian market for asset-backed economist) to Microeconomics 1, which securities, in particular mortgage-backed many of you probably studied. One of the securities. This is operated by a government first things you learn about is, what are the entity called the Canadian Housing conditions of perfectly competitive markets? Corporation, and it has performed well during Perfectly competitive markets are the current crisis. I’d encourage our people, economist’s artefacts for things that work whoever the relevant parties are, to look at beautifully. There are a bunch of similar models. characteristics, most of which apply to However, I would bet that the commercial financial markets. But there are two that I banks would resist any such idea. When I first think are the potential problem ones in started consulting with a particular commercial financial markets, and those are that the bank, I recall that there were about 450 basis product that’s being traded on any given points on mortgages. These were all genuine market needs to be homogenous, or, if you AAA-type mortgages, because they were all like, standardised. The second one is that all ‘Category A’, as they were called. It was just buyers and sellers need to be fully and ‘money-for-jam’ business. Through brokers and equally informed. Now, that isn’t always true, foreign competition and different sorts of so the oath that I would recommend originators, those margins have been squeezed regulators take each morning is: ‘Our role in down to quite healthy sorts of numbers, but still life today is to make markets work better by sensible sorts of numbers I think are in the helping create, one way or another, more interests of Australia. 64 Australian Securities and Investments Commission | ASIC Summer School 2009

I talk about standardised contracts, and the standardised definitions and calculation big advantage of standardised contracts is methodologies; better quality control in the that everybody knows what they’re buying due diligence process about what you’ve got and what they’re selling. Quite a bit of the and what you haven’t got; greater stuff that was big in the boom period—for transparency of the credit rating process; and example, CDOs (collateralised debt easier enforcement of the warranties obligations) and ‘CDOs squared’—was non- embedded in some of these things back to standard. Actually I suspect a lot of people, the originators (some of which I gather in the including a fair few of the participants, didn’t US were pretty vague and one would actually understand entirely what was going probably spend a few years in court trying to on with these products. enforce them).

I’m sure that the shire councils in Australia Can we rely on markets to fix these things? that bought some of these CDOs didn’t Well, my guess is largely yes, because if the actually know what the full distribution of markets and the participants in these payoffs might be with these things. markets don’t fix these things the markets Securitised investments in general are are not going to come back. The mortgage- classic cases in point. Now, I want to be very backed securities market in Australia at the clear, I think securitisation is a very, very moment is on its knees—and it actually was valuable innovation in the world of finance. a very well put together market. If they don’t At the end of the day, it creates cheaper somehow or other get confidence back in this credit for people, and in a legitimate sense, market, it’s not going to continue to exist and greater liquidity; it diversifies the risk across I think it’s in our interests as a society to have a wider spectrum of investors; it offers an this market working well again. additional asset class for private superannuants, and so on and so forth. If you As a little aside, talking about securitisation, I like to use the ‘slicing and dicing’ phrase, do want to talk about another popular topic of slicing and dicing in my opinion is good. recent times and that is what is known as the Defining and breaking up risk and spreading ‘Macquarie model’, which is the Macquarie it across as many parties as possible is good. Bank model. At least the way I see it, part of the Macquarie Bank model that people talk One of the ironies in this crunch that we have about is not about the traditional advisory had is that the investment banks were so business and the sorts of things that busy making money out of the churn that, Macquarie have been in for years, but the when the music stopped, a lot of these things Macquarie model of what is really a were still sitting on the balance sheets of sophisticated securitisation model, where the investment banks. securities end up being listed in a number of separate entities. I’m actually all in favour of the slicing and dicing. I think it’s absolutely in the interests of Now, this model is sort of ‘on-the-nose’ a little the overall system. However, there are some as I can read in the newspapers and from changes and I think some significant looking at the stock prices, even the changes required in the securitisation Macquarie Group share price has fallen by markets, the sorts of things that won’t an enormous amount. You know, these surprise you: greater disclosure; entities were very heavily geared and What went wrong: lessons from the boardroom 65

anything that is heavily geared in this sort of Everybody seems to believe, certainly in the event we have had—they do it tough. Assets US at least, that there was a lot of grade are getting revalued quickly and being inflation in the risk-rating process. brought to account and so on. I love to see the rating agencies get put over the grill. But I wouldn’t put that in the hands of Serious questions have been raised about a regulator either. I mean, I’m just horrified at this model—not picking on any particular the thought of a regulator cooking up different institution—about fee levels and maybe sorts of rules and regulations—you know, a some of the independence of governance bit of this, less of that, it should be an A arrangements, so on and so forth. There are minus—it would be frightening, even more a lot of questions. Of course, the market has frightening than the rating agencies doing it. passed its judgement on one or two of them already. The problem with the rating agencies was that their major source of revenue was the The point I want to make, though, is that this investment banks. They were rating these Macquarie model of securitisation (that is, packages of securities for the banks—isn’t using securitisation to fund infrastructure and there a moral hazard problem here? I mean, to list those entities) is a very, very good idea what’s their incentive? Their incentive is to rate and I hope the idea survives and I hope it them in a way that will keep their customer prospers. I suspect the fees won’t be quite as happy. We all like to keep the customer happy, juicy as they were before. I think the market and they also would. will insist on genuine arms’ length independence. Whether that was there I’m not picking on the morality or the ethics of before or not is a matter of opinion. I won’t rating agencies any more than anybody else. comment on that, but I think the fundamental We’re all in it for a buck; the way being in it for idea is a good one. a buck translated for them was to let some grade inflation slip in. Derivatives as well I think are a fantastic idea. Derivatives are highly desirable risk On the question of moral hazard, one management techniques in the part of the comment—where parties in a set of economy that’s now being dubbed the ‘real exchanges are insulated from the risk that economy’. (I thought the whole thing was the results from what they’re doing— ‘real’ economy. I think actually the financial I think that the moral hazard problem leads to sector is pretty ‘real’ too.) I think derivatives behaviours that are actually not in the are a terrific idea and I think they’ve added collective interest. an enormous amount and once again a lot of us didn’t have a clue what was going on. A I think that was probably the fundamental lot of the people inventing and creating these thing that went wrong in the US system. things and trading them probably didn’t know It absolutely flourishes in the ‘originate-and- either. I do think again this is a question distribute’ model for securities, which broadly about more transparency, more disclosure, I think is a pretty good model. But you really and entities like ASIC can add a lot of value, do have to make sure that there isn’t the at a minimum, by orchestrating these kinds of moral hazard problem. As the ball gets changes. flicked along the back line, the five eighth’s got to know that, if the winger gets crushed, 66 Australian Securities and Investments Commission | ASIC Summer School 2009

at the end the five-eighth was actually the answer to that, but let me make a start to get guy that caused the problem to begin with. a discussion going about why it doesn’t work You need to have recourse back to the five- as well as it might. eighth, those of you who follow rugby will understand. Firstly, I think Board members—non-executive directors, the ones I’ve spoken to over quite a ASIC, I think, needs to help the system long period of time—genuinely believe that ensure—though I hope the system is working there is a scarcity in executive talent, this out for itself to some extent—that you get particularly in CEO talent. It’s what I would call recourse back to the five-eighth relatively the ‘Brad Pitt’ or ‘Tiger Woods’ model of quickly and at relatively low cost. scarcity. You get just a couple that take 99% of the price. When I talk about the moral hazard problem, it’s not just the investment banks and the Now, logic says to me that can’t be true in rating agencies. One wonders whether the executive marketplace. I don’t mean just there’s a number of other players in the CEOs here, I mean executives in general. And system that might have suffered from the furthermore—and this is a terrible thing for a same problem. consultant to say, but I’m an ex-consultant now, so maybe I can get away with this—my I’m talking about people giving advice to observation over the years, both as an superannuation trustees, the proxy advisers, academic researcher and from my own casual and financial advisers advising each one of empiricism, is that the relationship between the us. Their incentive was to keep on loading us quality of a CEO and how well the company up with financial products rather than, say, performs is actually fairly loose. The major term deposits. They didn’t want to load us up drivers of company profitability, which are with term deposits because we could do that ultimately the major drivers of share prices, are for ourselves. They wanted to load us up with industry and macro-economic factors, not other stuff. Even lawyers might have had an whether the CEO does this or whether the CEO interest in playing the ‘fast music’ game. does that. The CEO is important, does play an important role, but it is still largely driven Finally I want to talk about executive externally. remuneration. As I said earlier, this is one market that seems to have not worked as The other comment I’d make here, by the well as a believer in the market like me might way, is again the moral hazard problem. Our have expected. The pay packets have been good friends the search firms have an unbelievable for some CEOs, but particularly incentive, as do the CEOs, to promote this investment bankers, private equity people, market and get it as hot as possible. The principals in hedge funds and so on. We all remuneration structure for the search firms is think that’s ridiculous. The bit that I find the that the more they kick up pay packets, the most disturbing is that it would appear that more their fees. Again, it’s one of these moral the relationship between the pay packet and hazard problems where remuneration is a performance was dubious. positive function of how much the consultant gets paid. So what’s wrong with this market? Why doesn’t this market actually work better than it seems to? I don’t claim to have the full What went wrong: lessons from the boardroom 67

Now, in my opinion the biggest problem in increase substantially. If you want to get the executive remuneration is the structure of the quality people that everybody says we need to deals. I will share a couple of thoughts I have have on Boards, I think we should actually about how you might do this a little bit reward them appropriately, like we do differently—firstly, they’ve been too short- everywhere else in the system. term. I think there needs to be a ‘moving Another comment I want to make is that I don’t average’ type clause in these structures over think it would have made any difference if we’d several years. had all these rules and regulations about no As I said, the fact is overall corporate Chairman being chief executive and all performance metrics—like share price and independent directors—you know, everybody’s total return to shareholders and profit—are got to bow three times at every meeting or largely driven by industry factors and by whatever it is—it wouldn’t have made any macroeconomic factors and by the state the difference to the global financial crisis. company is in when the CEO gets the job. Changing some rules and regulations about the The CEO, a really good CEO maybe, has a independence of directors is not going to make plus or minus 20% impact on how that any difference to the sort of situation that we actually turns out over a year or two. So I have been through. They’re not necessarily think corrections need to be made for those bad ideas by the way, but they’re not going to things before you start doing the make any difference. performance-based pay calculation. Let me sum up by saying, in my opinion, The other thing I don’t like is when you’ve got markets of all types are the heroes in our remuneration structures where the reward for systems not the villains, contrary to what we success outweighs the punishment for have been told in the last six months. Our task failure. But I really doubt whether a regulator is to help make the markets be more effective, could fix this any better than the Boards can. not to stop them from working. And we can do I think the Boards have taken the challenge that with key principles: by helping introduce on and I would largely leave it up to the public exchanges; by standardising products; Boards. and by helping make all buyers and sellers as fully informed as possible. Speaking of Boards, I think the remuneration structure for non-executive directors should 68 Australian Securities and Investments Commission | ASIC Summer School 2009

Panel discussion Moderator Mr Peter Thompson, ABC television and radio broadcaster Mr David Hoare, Chairman, Principal Global Investors (Australia) Ltd Ms Belinda Hutchinson AM, Non-Executive Director, QBE Insurance Group Ltd Ms Catherine Livingstone AO, Non-Executive Director, Telstra Corporations Ltd and Macquarie Bank Ltd Mr David Murray AO, Chairman, Future Fund

PETER THOMPSON eras), but I’ve got a bit of a feeling that Thank you John. With that grist for the mill, maybe we still run it today largely on the we will now move to the panel discussion. myth that things haven’t changed very much David Hoare, how do you respond to what and I suspect they’ve changed a great deal. John Stuckey had to say? Let’s start the batting. The providers of funds and the users of funds, of course, are no longer congruent DAVID HOARE and that’s a perfectly valid division of labour Maybe I could begin by acknowledging I’m sure, but with that there comes a John’s contribution to the discussion tonight. question of accountability and I think there’s I think the task of the construct of what he a lot of tenseness in the marketplace over has to say and putting some flesh around it is the extent to which that accountability is really a very substantial thing to undertake adequately discharged. So I think that the and John, I thank you on behalf of everyone limited liability model in the 21st century for the platform you’ve given us to perform might, if directors give some thought to it, on. perhaps play a more effective and more constructive role than perhaps it has done in Certainly, I would be totally in agreement with the past. your endorsement of the necessity to leave the solution of problems in the hands of PETER THOMPSON markets. I think it’s probably true to say that Could I pick you up on that? What’s the the failures that we have seen have perhaps alternative then if there’s a modification of been more in an inability to foresee what was this limited liability model? What’s the happening in systems rather than in markets, alternative that you see? and that’s an area that probably does need a great deal more attention. DAVID HOARE I don’t have a view that we want an But if, in fact, you accept the view that some alternative model. I don’t think we want two- sort of major failure or setback needs a bit of tiered governance like the Europeans. There a rethink, the matter I wanted to draw are two things I’d like to raise—there are attention to is whether in fact directors as a probably many others that people could think genre might give some thought as to how of—one is I think we have become obsessed effectively the ‘limited liability’ model was with the independent non-executive director actually operating in the 21st century. It’s 100 model. I’m still waiting for somebody to tell years old (it was a response to the capital me what ‘the director is independent of’. I raising needs of the Victorian and Edwardian What went wrong: lessons from the boardroom 69

think we have a love affair with it and I’d like CATHERINE LIVINGSTONE to see it discarded. Well, perhaps I’d like to pick up on David’s comment in relation to systems and markets. In some cases, of course, it does mean too I think we have to ‘hold our feet to the fire’ a close an association with the existing bit more rather than just say, ‘Let the market management. In other cases, it clearly meant sort it out’. age and, in one quite public instance that I saw referred to in the last month, it means Because what is a market? A market is a that simply somebody had been in a lengthy system and I think it’s incumbent on us to term of office and he had to move on. understand a great deal more about how systems work if we’re going to be living in I think there is no ‘one-size-fits-all’ for them. So the most surprising thing to me is Boards, so I would like to see the that we’re so surprised that the strength of independent notion put to one side. I the downturn has been so significant and so suspect, too, there is some use in having a broad globally. debate about whether in fact non-executive directors should have the same legal liability If you were an engineer and you looked at as executives. I think the notion of being the financial systems and you saw collegial around a Board is a very, very hard parameters going out of their normal one indeed. tolerances—for example, if you saw the size of the CDS market, if you saw leverage PETER THOMPSON hitting 30 to 1, if you saw the subprime Why do you raise this now? Why has this lending—as an engineer you’d be saying, crisis brought out this particular problem? ‘There’s something wrong with those parameters. We need to investigate and we DAVID HOARE need to bring the system back into a state of Because, in my view, it’s heightened tension control so it has predictable outcomes.’ on the matter of accountability. Unless Boards do better, execute better, then Not bringing parameters back into control companies are going to have a great deal of means the system ultimately goes so far out trouble raising the funds in the form and on of control it collapses and then you have no the scale and of the nature they want in the alternative but to take the whole system years ahead. down and bring it up again process by process. And one could argue that that’s PETER THOMPSON exactly what’s happening in terms of the So the corollary of that is there has been a nationalisation of banks and the bad bank failure of accountability? troubled assets process. DAVID HOARE I think the concept of markets as systems You’d have some trouble getting me to buy and our need for understanding how they that, but I can see why you might reason that work and then understanding how our way. products work in those systems is absolutely PETER THOMPSON crucial in terms of this concept of Right. I’ll come back to that. Catherine, accountability. Too many of the products where do you want to start? were working on the precept that they were 70 Australian Securities and Investments Commission | ASIC Summer School 2009

marginal in a system and therefore the risk BELINDA HUTCHINSON would be diversified, when in fact they were I agree with a number of points that so predominant they were mainstream in the Catherine has raised. Just getting back to system and were systemic and there was John’s speech first though, he talks about nowhere to go in terms of diversifying the moral hazard and it may be put in terms of risk. responsibility. I think everybody’s responsible right through from the policy makers, the PETER THOMPSON regulators, the banks, the Boards, the So the rebuilding of the system, do you see managers. Because I think if you look at the that as necessary beyond the financial issues, I think Catherine’s absolutely right sector? about some systemic problems and I think we’d be naive to think that regulation isn’t CATHERINE LIVINGSTONE going to increase. Well, absolutely and perhaps that just leads me to pick up on a tangential point in relation If I was in the US and was a taxpayer, I’d to Australia and I’ll use the term ‘real certainly think that the government should economy’, I know it’s a bit of a— change some regulations, particularly as they’ve put $800 billion into the financial PETER THOMPSON sector and are probably going to have to put John has problems with it. in more, a lot more—similarly in the UK with CATHERINE LIVINGSTONE RBS (Royal Bank of Scotland) and others. If Yes, so he has problems with the real you’ve got 95% effectively of the company, economy, but we—it’s fine if we bring up the you’d really want some oversight. financial systems globally, and ours in If you look at what went wrong on the Australia are faring better than most, but regulatory side and the policy maker’s side that’s not going to be the solution, because and throughout the system, we didn’t really actually what’s happening in Australia is, have a good understanding of systemic risk small business is bearing the brunt because and the complexity of the systems, the small business doesn’t have the capacity to financial market systems that have borrow. Margins are very high, the upfront developed. We all knew that excess liquidity fees are very high and there’s very little was out there—there was this massive margin for error. growth in credit securities, and there was this So our small business sector, if I can call it demand for yield. We all knew that there was that—lots of industry sectors—may go down some significant mispricing of risk and I think, so far that it cannot be brought back up, if you look, there was a very fundamental thereby compromising Australia’s problem in terms of risk management. The competitiveness overall. So I’d hate us to be risk management problem related to the fact sitting here thinking if we solved the financial we didn’t factor in how bad things could be. system then everything is back to normal, Our stress testing was really inadequate, because in fact small business in Australia is particularly in the US, particularly in the UK. the big employer. If you relate that back to Boards and PETER THOMPSON management of companies, then you look at Belinda? the companies where there have been What went wrong: lessons from the boardroom 71

problems and when you look at their risk system and in the case of the global financial management, their risk management was crisis there was a serious failure of policy and inadequate; they didn’t stress test their regulation. There was a serious failure of businesses. They significantly global trade policy and there was the underestimated how the markets could move currency misalignment between two of the and I think were lulled into a false sense of biggest traders. The serious failure of security around their ability to access monetary policy meant that normal financial financial markets for credit. leverage was allowed to run amuck and people paid far too much for their assets for a We really got away from some very, very very, very long time and returns on assets basic issues around cash flow management were artificially inflated. There was a serious and debt maturity profiles—very, very simple failure of regulation of leverage in financial issues that we all learnt in 101 economics institutions. and finance courses. But we got away from those because we got caught up in hype and Now, if you put all that in place and then we didn’t properly address the risks and we have a look at what’s in the system—of didn’t properly address the risk management course greed will take over. The worst thing issues around stress testing. So that would we can do now is to worry about exactly what be an issue that I think we should have a the new regulations should look like and to look at. worry about getting square on the greed. What we have to do now is to think about the PETER THOMPSON quality of the pathway out and, if we don’t David, how is it down there at the Future focus on a low inflationary pathway with high Fund? productivity improvement, we will have a double bunger crisis. DAVID MURRAY

Well, we are just investing away. We have a PETER THOMPSON very long-term legislated mandate which I So what’s the pathway? Just develop that a can tell you is a good thing—the longer the little further, the pathway ahead. term the better—and it’s interesting to watch what’s happened in the sovereign wealth DAVID MURRAY funds as all this has unfolded. When this sort of thing happens, there is no alternative other than for governments to I think we have got two very, very good leads step in and start doing things they don’t here already. The first is that you have to normally do. They have to step in and take look at the operation of a system. The only ownership of banks or guarantee their thing that sits between inputs and outputs is liabilities, a low stack of fiscal stimulus a system. arrangements that are most unusual. The force of these fiscal stimulus arrangements is The second insight is that, in order for us to highly unusual. We have seen fiscal stimulus have the freedom that we relish, there has to this year equal to one year’s real GDP be a set of property rights and a rule of law. growth. That is amazing, but it’s necessary. There is no such thing as a financial system The issue is that the normal consequence of out here and a real economy out here. There such fiscal stimulus will be a period of high is no such thing as a government out here inflation and the trick is to work out a path in and a private sector out here. It is one 72 Australian Securities and Investments Commission | ASIC Summer School 2009

a way we can minimise that risk from here should actually tighten them. So to have all and then allow the process of rethinking the procyclical regulation and then have the regulation to take its course. ‘tsunami’ is not a happy time, but we are not in a position of normal fixes. That’s what we Rethinking executive remuneration, all of must understand. The IMF (International these things, they are side issues at the Monetary Fund) has never revised its global moment. The real issue is how to get out of growth forecasts down as quickly as it has in this successfully. the last 12 months in its history.

PETER THOMPSON PETER THOMPSON Well, let’s come back to that issue about Let’s go with transparency and accountability getting out of it successfully later because for a moment. I know you—Catherine, do you the focus is mainly about the boardroom. want to— What about boardroom failure? Do you see a problem? CATHERINE LIVINGSTONE Can I just pick up on the procyclical nature of DAVID MURRAY regulation and just the role of regulators and Well, I think that commonsense tells you that, back to the systems issue? when some factors are wrong, you should step back and look at it. For example, in the If regulators had systems oversight—so period after the late 80s’ banking problem were executives actually looking at those and right now, there’s one question that parameters and raising alarms on the remains unanswered and that is why credit system, then we would avoid that procyclical growth ran so strongly ahead of nominal regulatory framework. The problem is we GDP growth. Had that been tackled with have regulators who are too reactive fervour each time, there might have been a because that’s their role. But if we change very different outcome. Serious questioning their role to be more pre-emptive, not to of that might have led people to understand constrain the market but just to make sure that a lot of regulation is procyclical, which is that the system in which the market is really hurting us right now. So nobody in the operating is in a state of control by working market— with those parameters—

PETER THOMPSON DAVID HOARE In other words, when the cycle is doing well, I think that Catherine’s made a very good regulation is light; when the cycle has done point. I think the positioning of regulators has very badly, regulation tends to clamp down. been such that they were encouraged, maybe covertly, to believe—well, I would say DAVID MURRAY the world’s flat—that assets could never be No one would accept that we can forego mispriced indefinitely. The result is that they some of this year’s profits in a bank by doing then tend to look at the idiosyncratic roughly calibrated dynamic provisioning for transaction-specific, entity-specific parts of a bad and doubtful debts. Nobody has marketplace. They do not rollback—this is questioned whether the prudential regulator the point Catherine is making, I agree—and should actually have higher capital ratios look at the system as a whole. when credit growth is running too far ahead of nominal GDP growth. But that’s when they What went wrong: lessons from the boardroom 73

DAVID MURRAY case of ‘blah blah blah’ company. I think I think that’s right. But typically regulators those are terrific points. don’t act in front of the system. You need regulators to be standing back a bit and also BELINDA HUTCHINSON Boards themselves. It’s very hard for a Board Can I make a point? Because I think one of to make statements that differ from what’s the things that you said, Peter, was in terms happening out there, especially when there’s of David’s point around procyclicality, what a consensus among the analysts, and when could Boards have done? I think it’s a really, there’s a litigious framework in which they’re really challenging question. The fact is, if held responsible for everything that happens everybody’s in this massive uplift and in a company. It makes it very difficult for a everything is going in the right direction and Board to sit back and say, what do we really we’re all looking for revenue growth and think? that’s what the analysts want and that’s what the investors want, it is very, very hard for a PETER THOMPSON Board and management team to sit back and One of the consequences of what you’re say, ‘Well, actually we think this is all a bit of saying about lending far outpacing economic a runaway train’. growth is that after this we need to accept a slower rate of growth. We’re all on this merry-go-round together sadly, but for one of us to put up our hands DAVID MURRAY and say, ‘We’re on this runaway train; things Yes, lock that in. We have to deleverage from aren’t looking too good’, it would actually cut the last party for a start and that deleveraging our growth forecast back to sort of 5% versus is very painful. But I think it was reported that 12% or 15% or 20%. Our share price would Britain’s debt is four times its GDP. It’s have all fallen in a hole and our shareholders unsustainable, so that deleveraging process would have said, ‘For God’s sake, get rid of has to happen and we have to get through that Board. What do they think they’re that as painlessly as possible. Hence the doing?’ wisdom of well thought out fiscal stimulus. Quite frankly, in Australia, we haven’t done JOHN STUCKEY that badly. There have been some high I’m feeling pretty relaxed about most of the profile cases of companies that haven’t been comments. I like the systemic comments. I prepared, but I think across the board we think the biology metaphor is actually pretty have done better than most. useful. I think a lot of companies have looked at the PETER THOMPSON environment and said, ‘This is getting a bit Very CSIRO sort of. out of control’ and ‘Let’s take a more conservative position’ on a whole range of JOHN STUCKEY things like revenue growth, like debt Yes, but it’s good, I like it. I think it goes in positioning, like cash flow management. with David’s comment, which is that the role of the Board and eventually regulators too is There has been, I think, quite a lot of good to stand back a bit more and take an overall work, but to get off that merry-go-round, it view, rather than reacting to the idiosyncratic would be very, very difficult to do. That’s why 74 Australian Securities and Investments Commission | ASIC Summer School 2009

I went back to the moral hazard How might the worst of this have been responsibility. We’re all in this together. avoided if things were better stress tested, because they would have always seemed PETER THOMPSON like that’s the marginal scenario? Everyone in the room, Catherine—do you see, if you agree with the point, do you see a BELINDA HUTCHINSON way of breaking out of that cycle? But we didn’t even have the marginal scenario on the table and I think we might CATHERINE LIVINGSTONE have prepared for it better. I think it comes back to what Belinda said previously and that’s stress testing. It’s CATHERINE LIVINGSTONE actually about understanding how you make And Peter, there would be certain products money and stress testing extreme scenarios, and strategies in the global environment that the one in 100, because nowadays the one in would not have happened because they 100 seems to happen every year, whether wouldn’t have survived the stress testing it’s floods or financial issues. You really have model and therefore the decision would have to be quite extreme with your stress testing to been not to promote them. make sure if the worst and unimaginable does happen, you’re still viable. BELINDA HUTCHINSON The excess liquidity I don’t believe would PETER THOMPSON have arisen if policy makers and regulators Because you raised the stress-testing thing, had had the right stress testing, so I think it is it a technical issue or is it a matter of moral was a failure of stress testing all the way responsibility? through, all the way down.

BELINDA HUTCHINSON PETER THOMPSON I think we really missed it. You look at the David, John Stuckey raised this issue of currency markets: who would have expected standardised products, loan products. Do you the Australian dollar to fall 35%? Nobody had agree with that? that in their models. Who would have expected interest rates to go down probably DAVID MURRAY to 2.75%? Who would have put that in their I disagree with standardising anything, but I models? You look at a whole range of issues, think what he meant was that exchange the equity markets, you just look at all these traded financial instruments are far superior markets and I defy anybody to put their hand to over-the-counter trade. up and say they got it right, because I don’t JOHN STUCKEY believe anybody got it right. Nobody saw this That’s what I meant. In a sense, as products massive volatility and this massive downturn have to be able to be exchanged in a public and decline in markets. I think we didn’t do a forum, they have to be reasonably good enough job, we didn’t do a good standardised. I didn’t mean standardised enough job. boring; I meant standardised so we knew

PETER THOMPSON what we were dealing with. Let me ask the hypothetical question then: given the experience, if this were to happen again, how would it have been different? What went wrong: lessons from the boardroom 75

PETER THOMPSON What the market is being asked to do now So, what do you make of the idea? What is to make decisions about primary and does the panel make of the idea of secondary investment on the basis of exchanges, more government-underwritten deduction, rather than on information direct exchanges of the sort of Canadian— from the company. I’ve long worried about ‘true and fair view’ statements. I’ve never sat JOHN STUCKEY around a Board and had numbers put to me No, no. in that particular form. I think the market really does want to know the metrics by PETER THOMPSON which management and the Board judges the I’ll take the ‘government’ word out—the future of the company. So I think there’s a Canadian Housing Corporation. really big issue where Boards could JOHN STUCKEY contribute a lot to how and when and the It’s just—the government provides a public form that information goes into the exchange, then the government gets out of it marketplace. after that. I’ll just make a point that I don’t see PETER THOMPSON any need for these things to be privatised Let’s stay with Boards for the moment and and profit-oriented like some public governance. Catherine, chief risk officers— exchanges are. That’s all. There’s no big some have suggested that they should sit on deal, but I don’t think there’s any great need Boards as executive members of Boards and for it either. That’s the point I was making. circumvent CEOs. More to the point is they’re public exchanges.

CATHERINE LIVINGSTONE PETER THOMPSON Absolutely not. The CEO is ultimately David, your point of view on that? responsible in the management team and the DAVID HOARE CEO has to have that team around them. I was going to go back to an issue you raised You can’t give predominance to one member a couple of minutes ago, Peter, and that was of the team, as if they’re carrying more of the the question of transparency. I’m sympathetic load than the other. to the points that Belinda has raised. It’s a PETER THOMPSON question of how can it be done better in the Well, CFOs sit on boards sometimes and future; I think a lot revolves around Boards some have suggested— considering what in fact they actually tell the marketplace, the form and the nature and the CATHERINE LIVINGSTONE timing of it. I suspect we will see there is They do, but not always. reluctance on the part of companies to give indications of or guidance on earnings. I think PETER THOMPSON that the market probably would like to know —heads of HR should sit on Boards? from companies where they see themselves in two or three years’ time and how they will CATHERINE LIVINGSTONE put the value into place that will bring that to I think if you start having half the successful fruition. management team on the Board, the distinction between Board and management is inevitably compromised. But back to the 76 Australian Securities and Investments Commission | ASIC Summer School 2009

point on the chief risk officer. The chief risk short time. I also share David’s view about officer is not carrying a special load relative this, you know, what does independence to the load that other people are carrying for really mean? I’ve no idea what it means. risk and managing risk. If they’re perceived Once you sign up to be on a Board, given the as being the keeper of the risk, then you’ve legal consequences and the consequences got a fundamental problem with your for your personal reputation, you are business. Risk has to be carried throughout anything but independent. the business. PETER THOMPSON PETER THOMPSON I’m going to come to questions about what David, I know you go further in terms of this shake-out might do, particularly what it governance and believe that there shouldn’t might do in a positive sense. Belinda? be committees of Boards. BELINDA HUTCHINSON DAVID MURRAY One of the things that I’d like to continue on Well, that’s true. I do believe that, thank you with is David’s point about transparency and for raising it. accountability. One of the things I really struggle with is the amount of information we PETER THOMPSON give investors. QBE’s annual report last year It was effortless, really. was 200-plus pages. A question to the audience is, who of our investors would read DAVID MURRAY every single page of that? I know the Board I believe the whole of the Board is and management do. But it is a real slog. accountable. If anything, a lot of these things There is a hell of a lot of information. It’s very arose because Boards are too big. If you look clear what our targets for performance are at the way Boards conduct themselves now, next year and where we’re going. Somehow they form different committees and everyone we have got to improve the communication. attends anyway. When we look at transparency from the It’s not got to do with whether there’s a perspective of executive remuneration, which committee and the appearance of David and I were talking about over dinner. independence. It’s got to do with who is in David and I are very much of the view that the room asking what at a particular point in the disclosure around executive time. For example, in the process of signing remuneration drove the situation we face off financial statements and dealing with today in terms of what is viewed as auditors, there are certain things that need to excessive remuneration out there. There was be asked of the auditors without the this competitive data that all the executives Chairman and Chief Executive in the room. could use and that executive remuneration That’s possible without having a committee, consultants could use, and because of that it so it goes on and on and on. all became another feeding frenzy. You can construct methods of doing things I think we have got a really big issue about that do not rely on committees. I think the disclosure and competitive information and only time a Board should ever form a how much we disclose and how we disclose committee is to do a short technical thing that it to our shareholders. But if you look at the a couple of people can deal with expertly in a What went wrong: lessons from the boardroom 77

executive remuneration situation we have better. But I have heard from a number of today, it’s very, very clear (I don’t know non-executive directors over the years and anyone on Boards and management who they quite genuinely believe that information doesn’t agree with this view) that we have going out there on the market about what his had this competitive spiral. We have got or her competitor was getting meant that they some changes to make. would get more money. I think that ‘ups the ante’ on the non-executive directors that I don’t think things are quite as bad on much more. executive remuneration as people might think. I think you’ll see this year that a lot of On this executive compensation thing, I was executives will get a lot less remuneration, hurrying a bit at the end of my talk and I want because I think in a lot of places the incentive to make a couple of other points and let me programs are going to work because they’re use the opportunity to do it now. around the right measures like return on equity, like absolute shareholder returns, I did say, I think, that I thought there was too those sort of things. much of the pay packet based on so-called performance-based pay. The part of There are some people who—companies performance-based pay that I have the that have got it wrong. Relative shareholder problem with, or where there’s too much of it, return obviously is not going to work for relates to the total performance of the people. I do think things are too short-term in company—you know, the total profit, the total nature. There’s been a big push to bring shareholder returns, whatever. The bulk of things to one to three years. We need to that result is not due to the CEO. The bulk of move it well out. Three to five years has got that result is due to what’s happening in the to be a minimum number in terms of these industry and what’s happening in the markets incentives. We have got to get rid of over all. So to give the CEO credit for all of termination payments. But I think there is this that in good times is I think artificial. big issue that is very much reflected in executive remuneration around transparency, On the other hand, of course, when things accountability, communication. I’d be are terrible (and they’re probably going to be interested to hear what other members of the terrible over the next year or two), much of panel have to say. the result is probably not due to the CEO. The CEO might actually be doing a really CATHERINE LIVINGSTONE good job in a tough environment. I think in terms of the disclosure I agree with Belinda, and it’s one of those examples of The other comment I would make is that I the perfect answer not being the right answer would max out that 50% of the performance- in terms of disclosure. So it’s been a trap, based component—which is based on that actually. sort of stuff I was talking about. The other 50% I would base on non-quantitative JOHN STUCKEY performance-based criteria. I don’t know how Can I have a bit of a go at that one? Not many Boards are doing this. being a non-executive director, I haven’t actually suffered under the pressure, so I What I would like to see is Boards stick to my principle: more information is considering several years ahead. I like the sort of timeframes Belinda is talking about. 78 Australian Securities and Investments Commission | ASIC Summer School 2009

Every several years, the CEO and the other circumstances that we witness, but I think executives should say, ‘This is what we want John’s point is the right one. to pull off over the next few years’. It should not be just financial stuff. It’s also about: ‘I The Board must be aware that they reserve really want to change the culture of this the right to make a judgement and it’s not company in the following sorts of ways’, or ‘I just about numbers because some of the really want to change the core of this financial engineers will outsmart you with the business from this to this’ or whatever it is— numbers. You reserve the right to make a some really, really quite substantial things. judgement on a number of factors and you sit there and make the judgement whether the As a random example, the CEO might say, ‘I CEO likes it or not—that’s what Boards have really want to get a decent IT system in this to do. It is a contract at the start. company without spending $1 billion’, which is what is normally seems to happen. The BELINDA HUTCHINSON CEO and the other executives would then be I would say on David’s point on term of assessed against how well they performed. CEOs, you look at the companies who The Board would have to do that perform and their CEOs aren’t there for a subjectively. You’d have to figure that out short-term. They’re there for a medium- to somehow or other however you do these long-term. I think that what we have really got things. And that’s what I would encourage, to encourage is the focus and the so there’s a full proper assessment of the commitment for the long-term CEO, so performance and that’s when then they get hopefully we can design performance-based the bucks. remuneration that does reflect that.

DAVID MURRAY The one thing I really struggle with—and I We have got to get rid of this notion that think a lot of Boards struggle with—is that, appointing a CEO is a long-term deal. If you yes, we can come up with a whole range of look at their average longevity, you actually subjective measurements, but when we go to have to have two people enter a contract. see the institutional investors they go, ‘I want Certainly in the mind of a new CEO that is alignment with me as a shareholder’. So if not a long-term contract. you start coming up with a whole range of subjective measures, there is a lot of PETER THOMPSON pushback. Hopefully we can come to some Three years is a typical term, isn’t it? arrangement whereby, say, 50% is more subjective, then align the interests with the DAVID MURRAY shareholders. But it is a big, big talking point What if it’s you entering a three-year with institutional shareholders. contract, what protections do you want in the contract? What happens is not unusual in the What went wrong: lessons from the boardroom 79

Questions from the audience

Question 1 (Adrian Blundell-Wignall) Shouldn’t we be changing the ‘fit and proper There are two institutions that are pretty person’ test to say we need more competitive important in this crisis, one is UBS and one is people and shouldn’t we be defining the Citigroup. Now, I just want to give you two fiduciary responsibilities of directors to at least Board examples from both of those fit with something that they can manage? institutions. DAVID MURRAY In the case of UBS, as early as 2006, the One of the things I found most difficult when Board said, ‘We are extremely concerned hiring somebody was whether the structure about the subprime issues and the emerging of the arrangement was commercial or subprime crisis’, and the investment bank entrepreneurial—that is, ‘commercial’ to me said, ‘Don’t be silly, sunshine, we’re making meant that we as a company were hiring an money here, just go away’, and the Board employee, ‘entrepreneurial’ meant that we basically said, ‘Don’t say we didn’t tell you’. were negotiating with a little business on So that’s the case. That’s literally what shoe leather. And if you adopt the happened. Very early on, the Board raised entrepreneurial style of employment, then the their concerns but they did nothing about it. outcome you heard from Bob Reuben is what you’ll get. Because you actually set people In the case of Citigroup, they had a Board up in the company as businesses in their member called Robert Reuben. This guy had own right and then have awful difficulty trying worked in Goldman Sachs and he was to change that. interviewed by journalists and the journalist said: ‘Robert, you’re a pretty smart guy, When people are driven by a formula-based Secretary of the Treasury, Goldman Sachs, remuneration, particularly in the investment how come you sort of didn’t like raise banking industry where remuneration was concerns?’ He said: ‘Well, you know, this is a generally regarded to have to be 40 to 50% very complex business; we hire people to of revenue, then this is terribly difficult to look at all these kinds of risk issues’. He unwind. And classically the unwind starts actually used the words, ‘I’m a bit of a side when you read in the newspaper that a whole show’. gang of structured finance experts is walking—has walked—across the street. Now, when you think about what’s going on Then you’ve got yourself a revolt with your there I guess the two points are, you’ve got a shareholders for all the wrong reasons. question in the one case about the culture of But to me, it’s got to do with the model of the organisation. When an organisation is employment and the model of remuneration making money, the Board seems to be very that goes with that. ineffective against the equity culture that’s going on there. In the other case, you have a CATHERINE LIVINGSTONE very complex institution where even a very Yes, but I’d also say that it has to do with the smart person like Robert Reuben isn’t on top strength of your risk management systems and of it. So this kind of raises a number of the processes through which you put your new issues. I’d be very interested in the panel’s products or new businesses for approval. It has comments. to do with assessing the risks and making sure 80 Australian Securities and Investments Commission | ASIC Summer School 2009

that you understand the products being raised that point and they said they were manufactured by the business. So it’s really going to ignore it, you’d have to resign. I incumbent on the Board to understand the don’t know what happened there exactly. strength of that new product or business And similarly if you’re Reuben and you’re on approval process and the risk management the Citibank Board and you feel like you’re a embedded in that process. sideshow, you would have to leave too.

To expect a Board member to understand I think it gets back to the point that Catherine the intricacies of products—whether it’s a made—you’ve got to have the right systems in financial product, a medical device, a motor place: risk management systems and risk vehicle—is not their role. Their role is to management departments in those sort of understand how products are designed, investment banks that can report to the Board manufactured and distributed and that is the on the risks that are being taken. And you’ve got same for financial institutions. So I’d come to be able to rely on them and trust them. If you back to the risk management systems again get a report back that you don’t like, you had and the stress testing again is what the better do something about the management and Board is responsible for. get rid of them, or you had better actually resign yourself if you can’t do that. DAVID HOARE Well, I think there’s a limited payback from Question 2 (name withheld) focusing on the stress testing of products at Why should there not be greater the Board level. I go back to the points that transparency about what happens in David Murray raised when he first spoke and companies so that shareholders can make these were big macro issues. They were decisions about whether to invest or not? systemic. DAVID MURRAY There were huge imbalances between Transparency—with you all the way. It’s just countries, with the US being tremendously that the Board of each company is very indebted to the rest of the world. Some proud of their company. And if you ask them, countries held a lot of those balances as they would say they want to appoint a better funds in their central banking function. They Chief Executive than next door. And when bought the short-term American paper. You you ask how they go about that, they say, enmesh that with financial innovation and ‘We pay at the 75th percentile’. Now, if every that’s a very difficult thing for a Board at an company in town pays at the 75th percentile, individual level to get their heads around. it’s not exactly the disclosure that’s the That’s where I think that the regulators problem, it’s the behaviour around it. probably need to be rethought and But I can tell you, before the disclosures repositioned. were in place, Boards did not have perfect BELINDA HUTCHINSON knowledge of what other CEOs were being I agree with David. Just in terms of Adrian’s paid. The problem with regulating remuneration point, though, I think if you were on those is you can stick it wherever you like. You can Boards and management said, ‘We’re not put it upfront or down the back or in he pension going to listen to you’, you’d have to resign. or wherever. So having perfect information If you were on the Board of UBS and you hasn’t helped. But that’s not an argument against transparency itself. What went wrong: lessons from the boardroom 81

BELINDA HUTCHINSON DAVID HOARE Look, I would agree with that. But I’ve got to The things that are broken are the global say—and I would agree with you in theory systems issues. They’ve got to be looked at and that it shouldn’t have made a difference—but organised in a different, more effective way. In CEOs and senior managers really had very respect of all the other things, my view is there little information that they could use to are a great many of them that are not self- compare and contrast. correcting, but are in the hands of Boards to correct and execute better in the future. David and I spoke earlier about this 75th th percentile or even the 66 percentile. You’ve I’ve been fascinated that we have spent the got this ratcheting process, which has made last 20 minutes on executive remuneration. it very, very difficult to put a lid on executive I reckon if you went out into Pitt Street and salaries. And again it’s moral hazard, asked somebody, they’d have a view on responsibility, whatever you might like to call executive remuneration. If you asked them it amongst everybody. It’s amongst Board, about derivatives, they wouldn’t know what management, consultants, and I think it’s a you’re talking about. The fact is, everyone big issue that needs to be addressed and it’s gets paid—it can be dealt with simplistically, a very complex issue. it can be beaten up, it’s a political touchstone. It’s got a villain and a hero. There’s no way I wasn’t trying to be flippant about it, but I do regulation can fix that, in my view. I think believe—and my practical experience has those are the things that are either self- been—that, as a result of disclosure, there correcting or in the hands of Boards to exe- has been a ratcheting up. cute better and they should be left that way. When it comes to disclosure around annual CATHERINE LIVINGSTONE reports, I’m not saying that we don’t need that Perhaps I could say what’s lost or what’s information. There is key information that’s missing rather than what’s broken, because needed. You know, there’s just an awful lot of we have covered what’s broken. But what’s information there that I really look at today and lost is trust and also the propensity to take say, is this really necessary? Is it what risk. And I think we’re actually suffering at shareholders want? And I really wonder the moment from the lack of the willingness whether we have got it right yet, because to take risk. there’s so much information that goes out there. It’s just voluminous and I really wonder BELINDA HUTCHINSON whether we’re hitting the point. And that was I would agree with Catherine on that. I think really more the point I was making. I just think the trust issue gets back to my point about we need to look at what we’re giving communication—we still need to do a lot of shareholders. I don’t think we have got the work with investors both institutional and retail. communication right. That was the point I was trying to make. I don’t think we’re giving our But I think in terms of what’s broken, I don’t shareholders what they really want. think that the corporate model we have for Boards and management isn’t working. I Question 3 (name withheld) think it is actually working. There are areas What is broken, what is self-correcting? for improvement and one of the ones we discussed was risk management and stress 82 Australian Securities and Investments Commission | ASIC Summer School 2009

testing. I think we also need to look at Boards alignment of things, is a far better course than and management in terms of what we’re trying to fix up everybody’s structure of pay. facing today and see whether we have the PETER THOMPSON right skills base to deal with this environment. What good might come of this (the global I think that’s important. financial crisis)? I think companies need to look at their CATHERINE LIVINGSTONE business models and make sure they are I actually think a lot of good will come from it, capable of withstanding what we’re going because people will actually understand their through. And so, generally, I think we need businesses a great deal more and that is to go back to basics around cash flow very positive for the economy. management, balance sheet management. We have had this unerring focus on revenue BELINDA HUTCHINSON growth and that side of the business, and we I totally agree with Catherine and that gets need to focus on a number of more difficult back to understanding the risk of the business issues at the moment. So I don’t think the and particularly the systemic risk, rather than system is broken. the individual risk that we used to focus on. So I think it could be a big positive. And I think also DAVID MURRAY in terms of the trust side of things, if we could There’s an issue with macro policy when two get the communication right, we can build on of the most important currencies in the world that. I think we actually have to build on that. are pegged. That needs to be sorted out. There’s an issue with monetary policy when DAVID MURRAY it takes into account traded goods prices Two things—first, the realisation that the but not asset prices, because it completely failure of HIH produced an enormous positive ignores the transmission effect through the rate of return to the Australian economy. And banking system. That needs attention. the second is a complete redefinition by what is meant by liquidity. Aside from that, the issues are more in the financial industry than the rest of industry. JOHN STUCKEY So a good starting point would be to leave One of the things I think is going to come out the rest of industry alone and sort out the is the relative prices of a whole bunch of issues in the financial system, which things, particularly assets. Assets will actually governments now have to do anyway. And get into line, the line that they should have whether we like it or not, governments been in and got out of for a long time. through the political process cannot tell their DAVID HOARE constituents that wrecking Citibank and I think David’s summed it up very well. It will be getting paid $150 million or something on the salutary and, in fact, we will do things better in way out the door is acceptable. So I think we the future as a result of having made mistakes have to understand what’s driven in the past. remuneration models in the financial system. PETER THOMPSON And I think that APRA’s starting point, where John, thank you very much for your opening and you go to the relationship between what’s stimulating comments. David, Catherine, Belinda happening to the capital and what’s happening and David, thank you very much. to the incentive structure and the timing and The future: a new financial order. Opening remarks 83

TUESDAY The future: a new financial order? Opening remarks

Mr Tony D’Aloisio, Chairman, ASIC

Good morning, everyone. At yesterday’s access to funding internationally. But plenaries, we looked at the causes and nevertheless, we heard from the group of lessons of the crisis and we looked at both regulators that there are issues in Australia the international and the Australian impacts. around corporate culture, executive remuneration, risk management and corporate Adrian Blundell-Wignall spoke about four governance, disclosure and transparency. catalysts that occurred in 2004 that he believed were really the cause of the crisis: Last evening, we had the boardroom the so-called ‘American Dream’ legislation; perspective. I think the point to us as Basel II; the SEC regulatory changes for regulators is that we should keep faith with investment banks and the Office of Federal the market, because the market ultimately Housing and Oversight; and Fannie May and fixes things, although it does need a little Freddie Mac controls. help. Really, to re-emphasise, the big global issues at the moment are around solvency of Adrian went on to say that there were a the banks in particular. number of facilitating factors, or regulatory failures, such as the credit rating agencies, Let’s move to this morning. So, what’s this accounting standards, poor underwriting morning about? This morning is really about standards, poor risk modelling, corporate looking at the shopping list for regulatory governance, and so on. changes and what needs to be done at the regulatory level. Before the morning break, I think two key issues that emerge for me we’re going to look at the US and the UK and from Adrian’s presentation and the panel more globally on what the key issues are, such discussions were the need to address the as credit rating agencies, securitisation, hedge solvency issue globally—that is, complete the funds and so on. And after the break, we will three steps that he outlined on guaranteed look at two specific issues: hedge funds and deposits, separating good and bad assets, securitisation. We will look at securitisation, in and recapitalising the banks. And, also the particular, because of its importance to the re- need to address the regulatory issues, opening of the markets. although probably right now they seem a little bit less important than the fixing of the so- Our objective for the morning is to give you a called ‘solvency crisis’. feel of the issues for reform, a stocktake of what those potential changes are going to be and We then moved to the domestic and the where they’re at in terms of consideration, both Australian situation and we heard how we had in Australia and overseas. Our first speaker is fared much better in this financial crisis due to Ms Kathleen Casey, Commissioner, US a number of factors, such as the four pillars Securities and Exchange Commission (SEC). policy, which as you know has been widely reported this morning, and tighter controls over 84 Australian Securities and Investments Commission | ASIC Summer School 2009

TUESDAY The future: a new financial order? Global markets, global solutions: the new global financial architecture

Ms Kathleen Casey, Commissioner, US Securities and Exchange Commission (SEC) Mr Hector Sants, Chief Executive Officer, Financial Services Authority, UK (pre-recorded interview by Ms Emma Alberici, ABC Europe Correspondent)

KATHLEEN CASEY made on a national basis can be amplified if Before I begin my remarks this morning, made collectively by the international I wanted to remind all of you that my community. comments today are my own and do not necessarily represent the views of my fellow Like other financial regulators, policy makers Commissioners of the SEC. and market participants, the SEC faced no shortage of issues in 2008 and I expect we I think it hardly needs stating that the current will be absorbing lessons from these times financial crisis has placed in stark relief the for a long period to come. The key will be fact that capital markets around the world are taking away the right lessons from recent increasingly interdependent. Unfortunately, in events and ensuring that they inform how we the current environment, this address the challenges and risks that interdependence means that all of our capital confront our markets today and in the future. markets have been under significant stress Any number of challenges could illustrate the for many months. This turmoil has prompted point, but I’d like to begin with the issue of a variety of responses at the national and short selling. international level and, before delving into the international responses to the crisis, I thought In the months following the precipitous fall of it would be useful to take a few moments this Bear Stearns last March, the SEC focused morning and share with you the SEC’s own increasingly on the role and impact of recent experience from a national potentially abusive naked short selling and perspective. other manipulative market practices in the securities of financial firms. In particular, I’d like to discuss some of the issues the SEC faced in 2008, some of the Last July, the SEC issued an emergency lessons we are learning from the market order aimed at preventing naked short selling turmoil, and how I think those challenges in the securities of Fannie May, Freddie Mac should inform how the SEC approaches its and certain primary dealers. The order came mission, as we move forward in the years to amid growing concerns about significant come. downward pressures on financial institutions, identified by the Federal Reserve as I believe our experience should also help systemically important, and it required inform how we respond to the crisis anyone effecting short sales in these internationally, because steps or missteps Global markets, global solutions: the new global financial architecture 85

securities to arrange beforehand to borrow While the effects of the ban, as well as the the securities and deliver them at settlement. previous emergency orders, are still being formally studied, we do know (based on the After the expiration of that temporary order, review of the SEC’s office of economic diminishing market confidence continued and analysis as well as studies and feedback indeed grew more acute culminating in the from both academics and market unprecedented events we witnessed in participants) that the short selling ban September, including at Fannie May, Freddie created significant disruptions and distortions Mac, AIG and Lehman Brothers. As a result, in markets and across the business activities the SEC took further action in mid- of a wide spectrum of financial market September, adopting three key short selling participants. provisions that still remain in effect today: At the time, undertaking such action required a requirement that short sellers and their us to balance several important broker dealers deliver securities by close considerations and I would say at that time of business three days after the sale we also had real fears about the downside of transaction date (or T+3) such a ban. While extraordinary market a rule eliminating the options market- conditions and great pressure led us to maker exception from the closeout impose these temporary measures, we requirement our regulations impose, and sought to carefully balance concerns about a new anti-fraud rule (rule 10b-21) which potentially abusive short selling against the expressly targeted fraudulent short selling likelihood of increased volatility, diminished transactions. liquidity and inhibitive price discovery.

The very next day, and I would say with great We also know that emergency actions by reluctance, the SEC took even more their very nature can add a further element of extraordinary action by issuing an emergency uncertainty to an already sensitive market order prohibiting short selling in the securities environment and that such uncertainty may of a wide array of financial firms. We took actually contribute to market instability. We these actions in close consultation with the are looking to market participants, our Federal Reserve and the Treasury economists and colleagues around the globe Department. to help us learn lessons from the impact of the temporary ban. In addition, the SEC also sought consultation and sought to coordinate with other securities In particular, the SEC staff continue to regulators around the world. From the outset, participate in the IOSCO Task Force on short the short sell ban was intended to be a selling, chaired by Martin Wheatley here temporary protective measure to give today, which is working to develop a common Congress and the administration the requisite approach to naked short sales delivery and time to adopt broader stabilisation measures. reporting requirements. In doing so, the Task And, after the Emergency Economic Force is seeking to minimise the adverse Stabilisation Act of 2008 was signed into law impacts of short sales regulation on in early October, the ban expired as planned legitimate securities lending, hedging and three business days later. other types of transactions that are critical to 86 Australian Securities and Investments Commission | ASIC Summer School 2009

capital formulation and reducing market While recommending against the suspension volatility. of fair value accounting standards, the report offers several important recommendations to Through these efforts, I hope that in the improve their application, such as: future we can fine-tune our responses to market events, minimise the potential developing additional guidance and other collateral consequences of our actions and tools for determining fair value when make decisions based on facts and data and relevant market information is not available not as concessions to fear. in a liquid or inactive market, and enhancing existing disclosure and In addition to short selling, fair value presentation requirements relating to the accounting occupied much of the SEC’s effect of fair value in financial statements. attention last year. Not surprisingly, accounting issues often find their way to Among its key findings, the report notes that centre stage in severe market environments investors generally believe fair value and the current period of subprime turmoil accounting enhances financial reporting and credit crisis has been no exception. transparency and facilitates better investment decision-making. The report also observes It has been said that, amid the pressure of that fair value accounting did not appear to great events, a general principle gives us no play a meaningful role in US bank failures help. So too, we saw certain principles that occurred in 2008. Rather, the report underlying market accounting tested as indicates that these appear to be the result of issuers dealt with the considerable pressures growing probable credit losses, concerns caused by inactive markets and the liquid about asset quality and, in certain cases, securities, recognising the need for clear eroding lender and investor confidence. direction to the markets last year. The SEC’s Division of Corporation Finance issued I’m quite hopeful that our study will be a guidance on fair value measurements and helpful tool as the Financial Accounting other disclosure issues that preparers could Standards and the International Accounting consider in preparing their periodic filings. Standards Boards address these issues. I believe that the report will be a useful In September last year, the SEC’s Office of source of information and guidance, not only Chief Accountant in coordination with the for us at the SEC, but also for policy makers staff of the Financial Accounting Standards in our Congress and independent standard Board jointly issued a release providing setters, as they continue to consider these clarification on certain aspects of FAS 157 important issues. itself, a guide to fair value measurements. Another key area of focus during the current Beyond these immediate regulatory crisis is the role and failures of credit ratings measures that the SEC took on its own and credit rating agencies, particularly with initiative, the US Congress also directed the regard to structured finance ratings. For SEC to review and study the use and effects nearly a century, ratings agencies were self- of fair value accounting standards and in late regulated in the United States and continue December, the SEC delivered the mandated to be in many parts of the world. That report. changed in 2006 with the passage of the US Global markets, global solutions: the new global financial architecture 87

Credit Rating Agency Reform Act whose financial products and traditional debt primary purposes were to promote products. competition in the rating industry, establish a transparent regulation system, and grant the The second would address the oligopoly in SEC comprehensive supervisory authority to the rating industry and the over reliance on conduct a robust inspection and examination ratings by removing the regulatory program to ensure that the rating agencies requirements embedded in SEC rules. are complying with the federal securities laws The third would require that rating agencies and operating in a manner consistent with make publicly available ratings history their disclosures. information for 100% of their current issue or The SEC proposed and adopted initial rules paid ratings. This is a significant pro- that established a registration scheme for competitive reform proposal in my view and I credit rating agencies, required important think it is vital that 100% of the credit ratings disclosures relating to their business are disclosed to investors and market operations and policies and procedures and participants. This will permit maximum to address certain conflicts of interest. comparability of ratings on an earnings-by- earnings or instrument-by-instrument basis. In early December, we adopted critical rule amendments and proposed additional The fourth would require the disclosure of the requirements designed to address concerns information a rating agency uses to issue a about credit ratings of residential mortgage- structured finance rating. It would facilitate backed securities backed by subprime competitive analysis by other rating agencies mortgage loans, and collateralised debt that are not paid by the issuer to rate the obligations linked to subprime loans. The product and these firms could issue amendments include enhanced ratings unsolicited ratings and the market could performance, measurement statistics, ultimately decide whose performance is disclosures of rating methodologies and superior. I believe these measures are rating histories, annual reports to the SEC of necessary and advisable and I’m quite credit rating actions and a series of hopeful that the SEC will act on them in the prohibitions relating to certain conflicts of near term. interest. I would also say that we continue to assess The rules we adopted in December I believe the efficacy and effectiveness of the previous paved the way for important change, but I do rules that we adopted last time and I believe not believe our work in this area is complete. that the SEC will probably undertake to look I continue to believe the SEC should act in at the conflicts of interest that continue to the near future on the other releases plague not just the issuer-paid model but also published for public comment in 2008 that the subscriber-based model as well. were not part of the final rules last year. In the midst of recent events, we have also The first proposal would seek to meaningfully taken steps to reduce counterparty risk and enhance disclosure to investors of the to bring more transparency, efficiency and different risk characteristics of structured structure to the credit default swaps markets. In late December, we approved temporary exemptions designed to facilitate the 88 Australian Securities and Investments Commission | ASIC Summer School 2009

development of centralised clearing. The sector groups such as the Counterparty Risk temporary exemptions are designed to Management Policy Group, and mixed enable central counterparties and their public–private sector groups such as the participants to implement centralised clearing G30, to name a few. quickly, while giving the SEC time to review their operations and evaluate whether The SEC has actively participated in many of regulations or permanent exemptions should these efforts and continues to engage in be granted in the future. international work streams to develop findings and recommendations. The SEC is The conditions that apply to the exemptions the chair of the IOSCO Task Force on credit are designed to provide that key investor rating agencies and has participated in the protections and important elements of SEC IOSCO Task Forces on unrelated entities oversight apply while taking into account that products and markets. applying all of the particulars of the securities laws could have the unintended In the Financial Stability Forum, the working consequence of deterring the prompt groups are looking at issues such as establishment and use of central procyclicality and supervisory colleges. counterparties. We have also contributed to the work being While the Congress considers the necessity done to prepare for the G20 meeting in early and appropriateness of potential legislation in April. This work addresses recommendations this area, I believe that the actions that the issued after the G20 summit on the financial SEC continues to take in this area should crisis last November. The recommendations begin to provide some much needed include reforms relating to credit rating transparency and discipline in this space. agencies, accounting standards and governance, risk management practices and The areas of ongoing work for the SEC that I international cooperation, as Tony mentioned just mentioned are not unique to the United earlier in his remarks. States and, in fact, occupy the agenda of a number of national governments and The agenda set by the various international international organisations. Over the course organisations that I mentioned are ambitious. of the past year, a tremendous amount of One of the goals of this work is to develop an work has been done by various prominent international infrastructure for financial international organisations and coordinating regulation to address the fact that the bodies to examine the root causes, failures, problems in our capital markets do not stop weaknesses and deficiencies that led to the at our national boarders. A key challenge is current markets dynamics and to propose that there is significant pressure on all potential reforms to the current architecture governments, regulators and international of financial regulation. organisations to find global solutions quickly.

These organisations include the G20, However, if we are to be effective in creating Financial Stability Forum, International a global approach to addressing financial Organisation of Securities Commissions crises where global approaches are (IOSCO), the Senior Supervisors Group and desirable, achievable and appropriate, it is all the Basel Committee, as well as private the more critical that we get the approach right. Given the US experience over the past Global markets, global solutions: the new global financial architecture 89

year, it is clear to me that fixing what has market participants, investors, consumer gone wrong will be a highly complex groups and others who feel the impact of the undertaking and highly complex problems present crisis. do not lend themselves to quick solutions. To conclude, I would leave with you two key In the United States and elsewhere, lessons that I’ve taken away from the SEC’s emergency actions have been taken to experience over the past year. resolve what were perceived as peaks in the financial crisis. These actions, although taken The first is that, while cooperation among for good reasons, have not ended the crisis regulators and governments is critical, so too and sometimes have had unintended is collaboration between regulators and negative consequences. This is partly due to market participants. We must continue to the fact that these actions were taken quickly work cooperatively together to address the without the benefit of adequate consultation many challenges that dynamic global with market participants and other markets pose and will continue to pose to stakeholders. financial stability into the future.

Creating the correct regulatory responses to The second is that we must be mindful of the the problems we are facing takes time. As law of unintended consequences. In markets the financial crisis drags on, it is important to of such complexity and interconnectedness, carry this lesson over to the international ill-conceived and ill-considered responses sphere. We should recognise that multi- can have adverse repercussions that can lateral efforts to stem the crisis, if taken on an quickly ripple through our global marketplace emergency basis, could suffer from the same to devastating effect. problem of producing unintended and As we continue to seek appropriate reforms possibly damaging consequences. This is not to enhance financial stability, we must remain to say that international efforts should be put vigilant and bring to our endeavour an on hold. appropriate measure of scepticism and Rather, they must continue with urgency and humbleness in recognising and appreciating are critical to building the foundation for the limits of even the most rigorous resolving the difficulties that our markets supervision and best private market face. As we collectively map out the future practices. oversight of the global capital markets, Thank you again for allowing me to speak to however, it is essential that we seek out a you this morning. path that is supported by strong empirical evidence and that is fully thought through, not just by government officials, but also by 90 Australian Securities and Investments Commission | ASIC Summer School 2009

Pre-recorded interview Mr Hector Sants, Chief Executive Officer, Financial Services Authority, UK (pre-recorded interview by Ms Emma Alberici, ABC Europe Correspondent)

TONY D’ALOISIO mandates. And the overall system and the We will now move to a pre-recorded risks inherent in it were not being properly interview with Hector Sants, the Chief considered in the round. So in that sense, Executive Officer of the Financial Services yes, I do think all of us with hindsight can see authority (FSA). He apologises for not being that things could have been done differently. able to come in person. I think no one institution, whether it be in the EMMA ALBERICI UK, the US or anywhere else in the world, Hector Sants, to what extent are regulators can be held responsible for this. I think it is a responsible for the global financial crisis? collective failure and, to a large degree, it’s a There’s been a lot of criticism of regulators collective intellectual failure and, to some around the world that they should have done degree, a failure of the wider global more to anticipate the banking collapse in community to really see the wood for the particular. trees.

HECTOR SANTS EMMA ALBERICI Well, I think it depends a little bit on what you You say that the mandate was about mean by regulators. I think as a general ensuring the quality of the market, but as it point, the system as a whole could have set turns out, the quality of the market wasn’t itself up better to anticipate—or put itself in a that good. better position to anticipate—what has gone wrong. HECTOR SANTS Absolutely. We have said—and I’m sure As we have said a number of times now in most regulators around the world would the UK in response to this question, we do recognise—that we could have done a better think it is fair to say that the FSA as a job, both in respect of challenging the supervisor was probably too focused on the individual institutions we supervise to think supervision of individual institutions and was about their own business models and not looking in the round at the wider macro- thinking in the round about how all the risks prudential agenda. fit together.

At the same time, our central bank would But I would make the point that we, along seem to have been too focused on its core with a lot of central banks around the world inflation agenda, rather than on financial and many respected economists and stability. But I think that comment could be commentators, were clearly focused on the made almost without exception across the fact that risk was being mispriced, that we world. That is, in general, finance ministers, were coming towards the end of what would regulators, central banks and institutions have undoubtedly been a remarkable boom, were very focused on their own particular set and that we were likely to go into a period of of circumstances, their own particular Global markets, global solutions: the new global financial architecture 91

significant economic difficulty with resultant certainly here in the UK, identify something credit losses and so forth. that falls into that category.

I think it is fair to say that we did not EMMA ALBERICI anticipate, nor I would say did anybody else You talk about there being a failure of vision. really anticipate, the collapse of the funding Had someone in the regulatory world had mechanism. I think it was a broadly accepted that vision, what could have come of that? truism across the global financial What difference could that have made? community—amongst regulators, central banks and commentators—that securitisation HECTOR SANTS and dispersal of risk was good. The fact that, Well, I think it’s a very interesting question actually, risk was still interlinked and had not and probably illuminates a number of really been dispersed to the degree that possible topics of debate. I will just pick out people believed, and was probably being maybe three points to respond to that mispriced in a way that would then create question. this catastrophic loss of confidence, I think Yes, first of all I would say even if the was not fully understood. I know the FSA did problem had been identified, there’s an not anticipate that and I don’t think anybody interesting issue around whether society in did. the round would have liked the solution. Over

EMMA ALBERICI here, there’s been quite a lot of talk about Should regulations have been tighter, or is it whether people would really have the fact that the regulations were there but appreciated it if the regulator had stopped the the enforcement wasn’t? party. I think our central bank governor used the phrase ‘taken away the punch bowl’. HECTOR SANTS I think we need to be always very careful with There’s no question that of course society as these phrases like ‘tighter’, ‘more’. To a large a whole enjoys a credit boom. Politicians degree I prefer the words ‘better’ and ‘more enjoy credit booms; politicians like to see effective’. I’m not convinced it was the cheap housing and cheap housing finance absence of enforcement. I think it was the being made available to their voters and so absence of intellectual vision by the forth. So there is a question as to whether regulatory community. society as a whole would have liked the answer, even if the regulatory community I come back to my earlier point: I think there’s had posed the question. been a failure of intellectual vision here by the regulatory authorities in the round to Certainly, here in the UK, our policy making anticipate how the whole system would react is very much a function of what happens in in a stressed set of circumstances in an Europe and, with regards to prudential economic downturn. I think it’s more a failure regulations, our European framework is very of vision rather than enforcement or much a read across from Basel. So we would deterrence. have had to make changes through a global framework. I don’t think in the UK, if the If we ask ourselves the counterfactual national regulator had tried to introduce question, is it something that we should have what’s called over here ‘gold plating’, we enforced against and we didn’t? I can’t, really would have been allowed to. I think the 92 Australian Securities and Investments Commission | ASIC Summer School 2009

pressure on us not to do so would have been credit out there to restart economies that immense. have gone into recession.

Having said that, I personally feel our job was Of course, those types of tactical actions to at least ask the question more stridently require intensive dialogue between the than we did, so I still feel we could have done regulators, the financial ministries, the central a better job in that respect. So that’s one banks and the market participants. I think observation. these discussions are going on around the world—certainly they’re going on in the UK— A second observation, of course, is we need but as you rightly say, at the same time we to be very careful here. We’re doing a ‘with- do have to think about the longer term. hindsight’ analysis of what happened. We don’t want to set ourselves up to give the We in the UK are publishing a discussion impression that in the future we can always document at the end of March laying out our get it right. thoughts on the wider regulatory framework, how it should evolve over the longer term Even if we analyse the lessons of the past from the FSA’s perspective. We hope it will here—yes, we can do a better job be a useful document to stimulate discussion collectively, I’m sure. But we don’t want to set with our counterparties around the world. ourselves up with society as saying it won’t happen again. I don’t think this particular set I’m sure everybody else is giving thought and of circumstances will happen again, but we will be publishing their thoughts. Indeed, all know that the history tells us that we go there have been a number of very interesting through boom-bust cycles and, to some contributions already made to the debate by degree, it’s inherent in market behaviour and a number of authorities around the world. the behaviour of individuals. No one is That longer-term debate is just starting within infallible, regulators are not infallible, and we the established fora for that, such as the should not set ourselves up as being Financial Stability Forum and so forth. So I infallible. think that process is going on, but at the moment, of course, the priority is on the EMMA ALBERICI shorter term. So are regulators around the world engaged with the investment banks about the kind of But I certainly encourage people to start financial engineering, if you like, that might thinking about the longer term now, because be allowed going forward and what might not one thing we do know is that it takes a very be allowed? long time for the global system to adjust. And one of the criticisms one would probably HECTOR SANTS make about the past is that the global system Yes. Of course, we have got the short term has been too slow to address significant and we have got the long term. There is problems when they’ve been perceived. For intensive discussion around the world with example, I think we know in the past we were regard to fixing the short-term problems, not quick enough to take forward reform of ensuring the inherent stability of the system the liquidity agenda for banks having and—in many economies—restarting the addressed the capital side through Basel II. lending process, ensuring there is enough Global markets, global solutions: the new global financial architecture 93

EMMA ALBERICI Now, of course, in the UK we do have banks Both the US and UK governments are now that are owned by governments so they can quite firmly focused on executive salaries. make that decision if they choose to. But that Did the bonus system in the financial sector for us is a decision for the shareholders, get out of control? whoever they might be, not for the regulator.

HECTOR SANTS EMMA ALBERICI We have been very clear on our views on Do you think short selling has had a this. I personally have been very clear on my considerable impact on financial instability? views on this since I took over the CEO role What impact do you think the ban has had on in July 2007 at the FSA. the market and the subsequent lifting of that ban? The FSA does think that the overall compensation framework, the incentive HECTOR SANTS framework, has not had the right balance Well, I think there have been different types between shareholder risks and employee of bans applied around the world and I think gain. In many banks, systems incentivised the set of circumstances under which they unreasonable risk taking, which has not were applied around the world have varied. worked out from the bank’s point of view or from the shareholder’s point of view. Having If you look at the UK, we were very clear said that, again back to some of the earlier about what we were trying to achieve and I comments about subprime—this is a have to say it was rather different, I suspect, contributing factor; it should certainly not be from what a lot of commentators have seen to be the sole factor. claimed. We do believe in the round that short selling is actually beneficial to market As a regulator, we think our focus should be efficiency and market quality. I think there are on the framework, the compensation system, plenty of studies that demonstrate that. We to try to ensure that it is aligned with good always said that and we haven’t changed our practice with regard to risk taking. We’re not view on it. in the business of setting absolute compensation levels. We think a good What happened to us in a particular period compensation approach from a regulatory towards the fourth quarter of last year was point of view is addressing the risk of that we were observing, with regard to our inappropriate incentivisation, and deposit taking institutions, significant falls in inappropriate behaviours. It’s not about share prices causing retail withdrawals. setting the absolute amount of money. Our point was thus, that rapid—very rapid—

EMMA ALBERICI falls in share prices could create a chain of So is it right to put a cap on bonuses? events that would then undermine the stability of those individual institutions HECTOR SANTS through retail withdrawals. In other words, That—as far as we see—that is a political share price movements—financial market question; that’s not a regulatory question. So movements as it were—were getting into the we very carefully steer away from that debate wider public domain and affecting the funding and I think that is for the owners. model of the institutions. 94 Australian Securities and Investments Commission | ASIC Summer School 2009

Therefore, in those circumstances, it seemed regard to crisis management. We do feel reasonable to seek to do everything you here in the UK—and I’m sure that will be felt could to minimise short-term, very rapid falls by many regulators around the world—that in share prices, which was the reason for when institutions actually got into a crisis banning shorting in that period. situation, got into difficulties, the degree of cooperation between international regulatory If it’s going to be banned, it has to be banned groups could have been better. We certainly across the board, across derivatives as well felt that in the UK and, of course, the as cash. There’s obviously no point in just understanding of each other’s particular set narrowly banning it in one component in the of circumstances could have been better. marketplace. So our rationale was about breaking the linkage between share price It’s a well-known fact here, for example, in the movement and consumer behaviour. It was UK, that the legal/administrative process of a not about market quality. We remain firmly of bank failing is very, very cumbersome and the view that long-term shorting is an difficult, which has been demonstrated in the absolutely legitimate investment technique Lehmans affair. Understanding how difficult and, in general, contributes to market quality. going into the legal/administrative process is in the UK would have been helpful to all. We’re currently consulting on improving transparency in respect to shorting, which we So I think there’s very much a clear case for hope and we believe will have good market focusing on how can we improve on mutual support here in the UK. But we see no understanding of crisis management and our evidence in terms of the narrow question of mechanisms for managing crisis, and that’s shorting in the quality of the marketplace to why we strongly support the college change the views that we have held for many approach and greater regulatory cooperation. years and we think are well supported by So that’s one point. academic studies. The second point which I think you were also EMMA ALBERICI leading to is a slightly different point as to the There’s been a lot of talk of global standard of regulation around the world, the coordination in the realm of regulatory standard of supervision, and do we need processes. In your view is there now an some mechanisms for trying to improve argument for some kind of standardisation in those standards, or trying to ensure that we global supervision, or even in harmonised can be confident as to the standards that all global standards? of us are reaching?

HECTOR SANTS I think, of course, we have seen some Well, of course, we do in theory have a pretty degree of unevenness of supervisory harmonised set of rules around prudential standards around the world, so I think we will regulation courtesy of Basel. But leaving that see increased pressure to address those to one side for the moment, I think we take issues and there are obviously bodies that out a couple of points from the recent crisis can do that, whether that be IOSCO, the with regard to global issues. Financial Stability Forum, and so forth. So I think there will be pressure for further work First of all, we would support much more on improving standards. detailed cooperation and integration with Global markets, global solutions: the new global financial architecture 95

I don’t think the current crisis in any way forward, which is looking towards the lead makes a case for a genuine, as it were, regulator, the home state regulator, the ‘global regulator’. As indeed, the current regulator of the parent body, taking the lead crisis has demonstrated that—at the end of to organise processes of information the day in a crisis situation—the other key exchange and cooperation amongst those elements are the legal regime, which remains other regulators that were involved in that obviously very national in character, and the institution. ‘who pays’ question, which has been very much brought to the fore. So although I think what’s critical, however, is to make analysis of the recent set of events will those discussion groups focused. Not encourage progress towards greater necessarily having everyone in the world, but supervisory integration, it will be very difficult, all the key players who are relevant to any but I think supervisory cooperation and given institution and make sure that there are standard setting are certainly going to be to meaningful discussions, that we actually talk the fore. about risks and issues of substance. There are some models out there and I think the I think the other question which is thrown up way forward is reasonably clear; we just in terms of the global international front is this need a will to take it forward. question of, could you have had some sort of radar mechanism? Could we have some EMMA ALBERICI mechanisms that would help us spot these If we say that behind every crisis lurks an events before they occur, some type of opportunity, do you see an opportunity global coordination in terms of risk radar? having come from the global financial crisis? That’s obviously a concept that is getting a HECTOR SANTS lot of traction at the moment. Yes, I think there are two opportunities, aren’t We know how difficult it is, as we said earlier, there? I think there is the opportunity to learn to foresee the future, but I do think we can in the narrow sense, some of which I’ve just usefully give consideration to that question been talking about—for example, improving as to whether some type of improved global our regulatory proposition, our regulatory mechanism could be put in place for spotting regime, liquidity, capital, shadow banking, problems. supervisory practices. I’m sure there are some other lessons, by the way, which we EMMA ALBERICI haven’t talked about in areas of accounting If we talk about some sort of international and so forth. So there is the narrow sense supervisory body or role and we look at where a set of lessons can be learnt. where we’re sitting here right now in the FSA—almost directly opposite is the old But I think the big opportunity that people Lehman building, an enormous structure in need to reflect on maybe takes us right back the London financial district, and yet you had to the beginning of this interview to a large no supervisory role there. degree, which is: we need to be careful here. Regulators are not infallible. Just fixing or HECTOR SANTS improving the current regulatory regime will We already have some models around the not stop another crisis of a different form Basel process, which I think shows the way appearing in the future at some time— 96 Australian Securities and Investments Commission | ASIC Summer School 2009

hopefully not in my time—but nevertheless at Now, that’s not for regulators alone and some time. maybe not necessarily in some of the sort of fora that regulators commonly congregate in, So maybe we want to really take the but I do think it is an interesting question that opportunity here to think about some of the society, as a whole, should ponder on. wider issues, such as the overall collective Whether, of course, they’ll come up with any responsibility for running a measured and definitive answers will be for others to judge sensible system that delivers to society over in the longer term. But I think there are some the longer term. So that really takes us back wider questions here that we shouldn’t forget to the beginning question of whose fault was that sit alongside the need for the regulators it? to take forward their own agenda.

Yes, a narrow regulator, national regulator EMMA ALBERICI could have done more, as we say in the UK More cultural issues? and I’m sure others would acknowledge. But at the end of the day it was an intellectual HECTOR SANTS failure of the system and not just finance Yes. But having said that, the first and ministries, regulators and central banks here. foremost responsibility as a regulator is to It is also society as a whole—governments, deal with those issues that clearly fall public policy, behaviour and so forth—so I squarely in our own area of responsibility. think there is an opportunity here to have a And we have indicated, I think, there is quite rather wider debate about the wider drivers a long list of those and therefore we need to that influence the financial system. focus on those first and foremost. I just thought it’s worth highlighting that there is a wider question.

Panel discussion Moderator Mr Tony D’Aloisio, Chairman, ASIC Ms Zarinah Anwar, Chairman, Securities Commission, Malaysia Ms Kathleen Casey, Commissioner, US Securities and Exchange Commission Mr Greg Tanzer, Secretary General, International Organization of Securities Commissions (IOSCO) Mr Martin Wheatley, Chief Executive Officer, Securities and Futures Commission, Hong Kong

TONY D’ALOISIO Okay, let’s get to the panel discussion. We Let’s move first, I think—Kathleen, just to will divide the panel discussion into two parts: start with you. In your presentation, you the first part essentially to look at the reform outlined some of the issues that the SEC is agenda and reform institutional architecture grappling with—short selling, credit rating more globally to effect changes, and the agencies, accounting standards. Looking at second part to then hone in on some of the the reform agenda for you more broadly over specific issues of reform that have come out the next few years, you didn’t mention such of the two presentations and indeed more issues as hedge funds, securitisation. Is generally yesterday. Global markets, global solutions: the new global financial architecture 97

there a broader reform agenda for the SEC in on what they believe additional reforms are. I terms of what’s come out of the crisis? think the Congress is already starting that process. KATHLEEN CASEY Well, I think with respect to hedge funds and For the SEC we don’t have the authority to other parts of the market that aren’t currently register—to require the registration of hedge regulated, there is a great deal of focus in the funds—without additional authority from the US right now about whether additional Congress and I think that, to the degree that regulation is necessary and appropriate, and we do provide input, it would be to suggest then, secondarily, what interest is sought to what additional oversight would provide to be achieved and regulated in those areas. both investors for market integrity issues as well as from the financial stability Right now, I think the debate is largely perspective. focused around the notion of systemic risk and trying to address issues associated with TONY D’ALOISIO contributors to systemic risk. So I think that’s One of the things we look for in terms of the the current focus of hedge fund regulation United States—and I accept that these are right now. I think that it’s still early to broader policy issues for Congress—but I appreciate just what the scope of that will be. think the Sarbanes-Oxley experience There are some discussions right now probably worried a number of markets in among policy makers to give consideration to terms of the prospective nature of that either registering hedge funds or hedge fund legislation. I just wonder do you see similar managers or advisers. The spirit there would approaches or different approaches this time be to try to collect greater information about around with Congress and policy makers? the exposures that they might pose to the Do you have a feel for how it’s going to be system. approached?

I think the real question will be whether or KATHLEEN CASEY not—if that’s encompassed in the notion of Is that a question of ambition in terms of how trying to address systemic risk—whether or forward leaning the regulatory responses will not systemic risk regulation would be be? included within the purview of the Federal Reserve or some other regulatory body, TONY D’ALOISIO whether or not it’s an existing one or some As to whether we’re going to see, I guess, other regulator that would be created to a series of legislative responses that may address systemic risk across the markets. well, in the longer term, inhibit recovery rather than assist. I think again the key issue here for policy makers is really trying to appreciate what KATHLEEN CASEY additional regulation is going to buy you and I think that was part of the spirit of my to be very clear about that, and I’m not remarks as well. I think there is always a certain that that debate has been fully great danger when responding to financial considered yet in the US. It’s just starting and crisis to overreact. I think that the fact that we I anticipate that, in the coming weeks, the have the experience of Sarbanes-Oxley administration is going to expose their view should hopefully inform the debate and the appreciation of what the consequences can 98 Australian Securities and Investments Commission | ASIC Summer School 2009

be if policy approaches aren’t carefully legal systems, against the overall drive to considered. have a more consistent, coherent and single view out of Europe. It’s my hope that that’s exactly what will happen this time around. I do believe again You have seen last week developments the debate is a little bit difficult because through the release of the Larosiere Report, during Sarbanes-Oxley—the Sarbanes-Oxley which is really aimed at greater integration debate in Congress—I don’t think there was within Europe of regulatory structure and, a full perception of the global implications of therefore, of hopefully driving that European the law. I think that’s changed. economy forward as a whole.

Again, I think that the engagement and the TONY D’ALOISIO cooperation, the collaboration at the In doing that, has that actually been done international level, is markedly different. with an eye on the United States? Sarbanes-Oxley was viewed as a domestic response and I don’t think that’s the same GREG TANZER paradigm we have today. Absolutely.

TONY D’ALOISIO TONY D’ALOISIO Greg, you’ve got the unique experience as And UK and vice versa? Secretary General of IOSCO of really seeing GREG TANZER this regulatory reform agenda unfold. You’re Absolutely. seeing it unfold in the United States as we have just been talking. What’s your view of TONY D’ALOISIO how it’s unfolding in, say, Europe, the UK, Are these systems developing? We will talk because critically for capital markets, those to each other, but really national issues may two markets (or those sets of markets) are well override international cooperation. important. How are you seeing it unfold in Europe? GREG TANZER No, absolutely. I think Europe sees itself at GREG TANZER the highest levels, the highest political levels, Europe is undergoing tremendous as very much part of this debate. It is about transformation in terms of its own political being able to develop an economy, which is make-up, in terms of the economic not just a counterfoil to the US, but another environment. Europe has long been linked economic force within the world. It is about economically. The political linkages that are Europe having a part to play and a say in now there are increasingly influential on how how this all advances, and not the United they perceive issues and how they regulate States economy driving the whole of the their market. world.

But my perception, from having lived there Also within Europe, there’s quite an overt for one year, is that increasingly you’re recognition that different people have seeing that clash (which is also being played different objectives. I think what you’re out at the international level) of national seeing is a much more common drive to differences and national differences in accept that those differences exist, but they structure, in culture, in legal backgrounds, in Global markets, global solutions: the new global financial architecture 99

want to move forward and come up with a regulators in each jurisdiction, IOSCO—who standard view. else will drive this agenda?

And I think it’s actually a tremendous GREG TANZER endeavour and—from an international I think when you think about being influential, organisation’s point of view—I think it is really influence comes from two things, doesn’t it? quite instructive. While describing and One is having something sensible to say and understanding what the differences are, we the second is having the authority to impose need to drive it forward and work out what we or drive it forward. can do to nail the problem, notwithstanding the differences that are there. International organisations have always suffered under the second one because TONY D’ALOISIO authority ultimately derives from parliaments The issues that Kathleen mentioned in terms and legislative mandates and, in fact, the of short selling, credit rating agencies—we business of regulation when you think about mentioned hedge funds, securitisation—are it, is not made up of some all-seeing, all- the European issues similar, the same? Are powerful brain that kind of manages the we dealing with the same issues? whole thing and moves it all around. Regulation is made up of a whole series of GREG TANZER individual actions that take place at a very In fact, from the European perspective, local level, which builds a system, and that probably even more so. There are a lot of necessarily involves national regulators interesting issues. For example, around having the direct responsibility themselves. hedge funds, there is a key issue about the extent of regulatory control that should be So international organisations are always imposed. going to be in a position not necessarily of being the one big all-seeing, all-knowing There are differences of view between some mind that has authority to stamp down on this of the continental Europeans and, for institution or another. It’s much more about example, the UK on credit rating agencies. bringing people together to discuss common The European Commission have got their problems and then come up with a common own initiatives at the moment setting up their solution. own registration scheme for credit rating agencies based on the IOSCO code of TONY D’ALOISIO conduct for credit rating agencies. There is If I take that a bit further and pass to Martin. also a lot of interest and debate within the The fact is these bodies—such as IOSCO, regulatory community about the appropriate the Financial Stability Forum, Joint Forum role for accounting standards. We will and so on—have all been in place during the probably come back to that. crisis, so the issue is what is it that is going to occur now that would be different to get us to TONY D’ALOISIO make changes? In other words, should we Let’s move to who will drive the architecture, just leave it to the existing bodies to effect who will drive the international reform the sorts of changes that are needed agenda, regulatory agenda, including internationally or does the structure itself, the governments—but in terms of the regulatory architecture itself, need to be reviewed? issues I guess we would say there’s the 100 Australian Securities and Investments Commission | ASIC Summer School 2009

MARTIN WHEATLEY the point that Greg and Martin made just now I think the point’s been made. The regulatory in terms of the difficulty of trying to integrate authorities, the international bodies can set and harmonise standards, we have worked standards, but they can’t impose standards in at harmonisation of certain standards over and of themselves. the last three to four years. Finally, when those standards have been agreed, the We have all been dealing with different implementation is a major challenge because aspects of this crisis. But we’re not dealing each jurisdiction will have to pass new laws, with it within an international legal system adopt the new standards, and change their and that means the response has to be using guidelines and their rules. the tools that are available, which are national tools. And let’s not forget it, the So in other words, while international taxpayer has to pay—I mean, in many organisations may set standards, I think it’s countries, the taxpayer is ultimately bailing the implementation that is going to be a out this crisis. The taxpayer is a voter and major challenge. I think you have to look at voters are what put governments in power, the different levels of development of the so it’s always going to be ultimately a various jurisdictions and to what extent each national issue. of these jurisdictions, each of the markets, are actually able to accept the changes, to What takes it above being a national issue is accept the standards and to impose the that these global bodies are given greater standards in the markets, taking into account authority by the supernational groups like the the level of maturity and sophistication of the G20, which is imposing a set of political markets. requirements over the top of national governments. So I think more is needed. I In a sense, I suppose, emerging markets are don’t think that the international bodies of fortunate because liberalisation, deregulation themselves can achieve this, but the has taken place at a much slower pace and, supernational will that is coming through from therefore, there is the opportunity to observe, the G20, and will come through from other to learn, and to pick out the best standards. groups, is what’s needed in addition. So if you take the short selling bans that were imposed in many markets, in many of TONY D’ALOISIO the emerging countries in Asia, there was no Zarinah, what’s your view on whether the necessity to take such action. existing architecture will work for us? In Malaysia, for example, we still have not ZARINAH ANWAR forgotten the Asian financial crisis and the Thank you. Perhaps I could look at that from lessons learned from that crisis. Short selling the perspective of the emerging markets, had been banned during the Asian crisis and, particularly in Asia. At the ASEAN level, we as regulators, we had to do some convincing have the ASEAN economic blueprint that to assure the government that short selling is strives for economic integration by the year a tool that needs to be reintroduced into the 2015. market. When we reintroduced it, it was accompanied by various restrictions; so there At the capital markets level, there is a project was no naked short selling. It had to be that’s ongoing to look at the integration of the accompanied by securities borrowing and ASEAN capital markets, and just to take on Global markets, global solutions: the new global financial architecture 101

lending. We had the ‘up-tick rule’, selected Now, Hector’s call for more vision and a the 100 most liquid stocks that short selling broader view of what’s going on in markets is can apply to. So there was already a lot of absolutely right. We do need to do that. As regulation and restrictions, such that, when Zarinah mentioned, in Asia we avoided some the ban was imposed in many other markets, of these problems because of the relative we didn’t have to do anything at all. recent memory of the Asian financial crisis and many elements that were put in place TONY D’ALOISIO after that, whether it be short selling or the If we pick up a couple of Hector Sants’ way that banks looked after capital. These comments—still staying within the reform are still in place too and they’ve helped us. agenda—he said overall there had been a collective failure of intellectual vision. Then Arguably, we should have seen some of the when he was asked about the further signs earlier, the failure of Long Term Capital question about how to deal with that, as to Management, and of Amaranth, were both whether you need greater harmonisation trigger points that should have said, ‘hang on internationally and an international oversight there’s a massive amount of leverage in this supervisory body, he agreed I think with the system, could this spill over to be a much harmonisation and said it was well underway, bigger problem?’ but had reservations about an international oversight and supervisory body. What we failed, and all of us collectively failed, to see was that the root of the problem would In this challenge that’s ahead of us—this is to come from within the regulated sector. So the panel—are we, in the way that the reform even two years ago, maybe three years ago, agenda is shaping up, are we comfortable we were talking collectively as regulators, that we can’t have a collective failure of saying the biggest fear we faced is from the intellectual vision again? unregulated sector—that is, a hedge fund or a group of hedge funds collectively taking down MARTIN WHEATLEY the people who provide liquidity to them. That Hector’s point was absolutely we will have was the fear, so in the sense that the vision we that collective failure again, but I think his had three years ago was looking at the hope was, not in his career or not in his potential for a problem existing, or a lifetime. Regulators are a bit like army recognition that there was underpricing of risk generals: we have always got the best in the system, that was known. strategy for fighting the last war and it’s a bit like that with markets. Recognition that there was over-leverage in the system—that was known. Recognition We understand—I think we have got a good that people paid themselves too much in understanding now of what went wrong and investment banks—that was known. What we we have got a reasonable understanding of didn’t see was that the result of that would be the things that need to be put right. The next an implosion of the banking sector, not the problem will be a different problem by clients to whom they provide the leverage. definition and almost by definition we won’t have the set of tools that allow us to deal with Now, the question is, will the vision next time that next problem. around make it any better? I think we will learn a lot from this process and I think we 102 Australian Securities and Investments Commission | ASIC Summer School 2009

will put in place mechanisms that mean we flows, but not quite properly appreciating that will look beyond the strict remit of regulators. a problem in a particular market, albeit a very But by definition, the next problem is going to large market, would then spread into other be a different problem. markets and more significantly diminish investor confidence. TONY D’ALOISIO Greg, do you feel we are moving in that TONY D’ALOISIO direction? Zarinah, do you want to comment on that?

GREG TANZER ZARINAH ANWAR Yes, I think we are. I think another way to Yes. I think one area perhaps that we have look at it is—I think one of the issues that learned and should learn from for the future we’re dealing with at the moment is the role is in terms of regulatory capture. I think in of the credit rating agencies. Well, that was trying to discharge our role and our actually an issue that we did identify some responsibilities, there is, of course, a lot of time ago. IOSCO started working on this in influence that is being exercised from 2001. We came up with a code of conduct, different stakeholders trying to exercise which was aimed at improving the quality of influence over decision-making and standards and at dealing with the conflicts of judgement by regulators. I think one lesson interest. I don’t say for a moment that it’s we should learn from here is that regulators perfect. It’s not perfect. We did actually pick have got to avoid this kind of capture. the right issue when we started working on it in quite a practical and sensible way. Capture can come from politicians, and particularly from the big institutions. Naturally The lesson is perhaps to just be a little bit in the course of developing themselves to bolder about pushing that a bit further. Hector what they are today, to the size that they are was talking about taking away the punch today and to the degree of systemic influence bowl. I don’t know if you necessarily have to that these institutions have, relationships take away the punch bowl all the time, but have been established and therefore certain you might be quite overtly adding a lot more influences may prevail in terms of the orange juice to the punch bowl just to slow applicability of rules and regulations to these things down a little bit and saying, ‘I’m sorry, institutions. I’m being transparent. There’s a big bucket of orange juice that’s going in here as well.’ And I feel very strongly that rules have got to be on credit rating agencies, we know perhaps applied across the board, irrespective of that is what we should have done with the whether these institutions are big or small, benefit of hindsight. But I do see a real will and I think we need to be very much more and desire, around the IOSCO table anyway, vigilant in terms of the applicability of such to try to focus on what the key systemic rules and to avoid such regulatory capture. issues are. MARTIN WHEATLEY Zarinah puts the key issues around capacity Can I comment on this? This concept of building, because the other great lesson from regulatory capture, I think, is an important this crisis is, I think a lot of people were still in one, and clearly it behoves us as regulators the mindset of talking about cross-border not to become close to the point of actually Global markets, global solutions: the new global financial architecture 103

not regulating effectively the major Hector, which is even when we perceive risks investment banks. early, and perceive certain issues as regulators that need to be addressed, it’s quite challenging But the truth is, it was only three years ago, to do so absent crisis, or some sort of stimulant maybe four years ago, that the majority of in the market or some sort of scandal. Because New York banks and various others were there’s just not sufficient will often times, or you recruiting McKinsey to say, ‘How can we be get the significant kind of pressures or pushback more competitive? What do we have to do from a competitive perspective. Not that they’re with our regulatory structure to make us more not fair points to be made, but if you’re doing this competitive vis-a-vis London.’ on a national basis, it’s going to put a lot of the key market participants at a competitive So actually we all faced this massive pressure disadvantage. from politicians for ‘light touch, please’. Light touch regulation, that’s what we want to grow: It makes it quite challenging to undertake those we want lots of innovative products; we all kinds of reforms, and on the credit rating agency want to represent international financial side, again, understanding just how long efforts centres. So the capture is not just from the were made. Conflicts were recognised for some industry; it is from politicians who at different time—the dominance of the two or three biggest parts of the cycle are saying, ‘back off’. rating agencies and the challenges that was posing, the conflicts that were driving a lack of KATHLEEN CASEY confidence in the marketplace, the accountability I agree with everything that Martin just said of rating agencies—I think were all long as well about the pressures that regulators perceived and suspected. are often placed under. Just two years ago, it was a completely different debate about the I don’t think anybody had a full appreciation nature and adequacy of regulation. I think until we saw them play out for the current that it’s still fair to say that some of the points crisis, but I think that’s just a fair point to that were made are still fair today. I don’t make in terms of recognising the reality of think you had to take away that it was—I still the dynamics that we often face. So that have a problem with this debate about when we are able even to perceive certain overregulation or underregulation. risks, it can be quite challenging to undertake to adopt those reforms in a timely way. I don’t think that accurately states the nature of the problems we face. I think Hector’s TONY D’ALOISIO points were well taken too in terms of just Thank you. I’m going to open up this first part again a broader intellectual failure, which to some questions from the floor now we’re ensures from our perspective that again we really coming to grips with the reform agenda, will likely miss, maybe at least as far as the then to the architecture or the bodies to pursue timing of, what the next challenge will be for that agenda. And I think the consensus we’re our markets. coming to is to stay within the existing framework and try and improve the existing I think that I’d also like to go back to what Greg international frameworks. said earlier, which was also mentioned by 104 Australian Securities and Investments Commission | ASIC Summer School 2009

Questions from the audience (names withheld)

Question 1 information being provided by lenders on Going to the last few remarks—I don’t want delinquency rates and so on. What they to say much about the question of regulation weren’t doing was testing whether or not of the credit rating agencies, which of course some of that information was true. has already been under consideration by IOSCO, the SEC, and the Minister here has I’m not saying they should go out and speak made a statement about that. But reading a to every lender in the world and find out paper by Professor John Coffee of Columbia, whether they’ve truly declared their income which was delivered at the University of and so on. Actually they used to do a little bit Sydney here last year, his criticism was that of that; they used to go out and do a little bit they basically had to rate fairly quickly on the of spot checking just to see if that threw up basis of information supplied by the lenders. any problems. I think that’s quite appropriate because, at the end of the day, the credit I thought, well, what he’s really implying is rating agencies have to prove a value that—in relation to these instruments—there proposition. If the rating is of such poor should be in effect a full due diligence, an quality that you have significant changes in a independent due diligence. Then I thought, rating in a very short time then that’s going to goodness me, the credit rating agencies are reflect on their business model and people rating governments, corporations, funds, a won’t be prepared to pay for it. vast range of instruments, and they’re all expected to do it very quickly. If you were to A lot of the confidence that you see sapped have a true rating of quality, at least in out of the industry is because of exactly that. relation to instruments, does this mean we I think you are right that it’s not a question of have to move more slowly and move to a full a credit rating agency effectively having to due diligence? How does one solve that perform full due diligence in order to make problem? exactly the same judgement that the lender should be making in the first place, but GREG TANZER there’s something in between that and just One of the big issues of debate with the accepting any information that you’re given credit rating agencies, is the amount of due and not testing it when your business diligence that they should actually perform on reputation is on the line. the information they get. I think it’s reasonable to say that the credit rating KATHLEEN CASEY agencies themselves would agree that some I think one of the reforms that has been years back they used to do a lot more due undertaken to address that issue has been at diligence than they do now. least improving the disclosure that rating agencies make on the due diligence that they In fact, when you refer to relying on do engage in, so that markets can be information provided by lenders, the credit appreciative of how much diligence they rating agencies would say that they were engage in when they issue a particular rating. getting more information in more recent times. They were putting it through their I think the other reform that I believe would models, but they were relying on the help address this would be the requirement that the information that underlies the Global markets, global solutions: the new global financial architecture 105

particular rating be disclosed to other rating taken out of the system, again that you would agencies in a timely way so that other rating think cost imperatives would drive. agencies can provide unsolicited ratings. So I think the spirit there is you’d have other I think one of the interesting observations out rating agencies who might be able to of that is there is also a market interest, compete on quality. And so, another especially for some players, in opacity as disciplinary effect—on diminishing the much is a there is from a regulatory incentive some rating agencies might have to perspective sometimes in transparency. not engage in the kind of due diligence that Tony? you would hope—would be effected by the TONY D’ALOISIO fact there would be other rating agencies What I’d like to do now in the remaining time who would have access to the same raw is to move to hit some of the specific issues data they used to support their rating. around the reform agenda in a little bit more Question 2 detail. We have covered quite a number, I’m just interested in whether there is a particularly credit rating agencies. reform agenda for the OTC (over-the- One that’s only of remote relevance to counter) markets, given the international Australia is short selling at the moment, so nature of them and the fact that when dealing given its remote relevance, Martin, would you in those markets, quite often there are update us on where IOSCO is at with short transborder transactions that obviously selling at this point? impinge on various jurisdictions and regulators? MARTIN WHEATLEY Sure, obviously short selling has become a GREG TANZER very hot potato in pretty well every market in IOSCO’s got a current task force that’s the world. I know it’s a particularly sensitive looking at unregulated markets and products, issue in Australia, but obviously the US, the and one of the particular areas of focus UK and other markets, they have all taken relates to the credit default swap (CDS) different forms of bans at different times and market. some of those are still in place. Tony’s group is working on that and the IOSCO took the view back in, I think, October observations of that should come out in the that we should have, as best we could, a next month or so. When you look at OTC collective view about what were good markets, one of the things that’s surprising to principles of regulating a short selling me anyway as a regulator, is that this is a structure. So we brought together a group very substantial market with very substantial that—and I’m hoping in the next couple of players. Yet it hasn’t developed some of the weeks—will publish a report on what we think characteristics that you would normally see we can agree are principles on short selling. flow from a very large market. You haven’t had as much standardisation of the product The one thing—not withstanding the speaker as you would expect the cost imperatives last night who mentioned the quote that short might drive. You haven’t had the natural sellers should be put up on a wall and shot— development of clearing and settlement the general view of regulators is that well- frameworks that ensure all of that risk is structured short selling has a very strong 106 Australian Securities and Investments Commission | ASIC Summer School 2009

place in a market. It provides liquidity, The IOSCO Task Force on short selling enhancing price discovery and should be a represents regulators from all the major feature of markets. Having said that, the well- jurisdictions, including ASIC, and it will come regulated component of it is the important out with some high level principles. We won’t part and there’s a lot of concern about the come out with the fine detail, because I think extent to which naked short selling can we have probably got another round to go become an abusive feature. through to get to that.

The general view is that it’s very difficult TONY D’ALOISIO legally and definitionally to find a way to ban One of the things we saw when the bans naked short selling per se. Some markets do were being put on—and we saw the different it—we in Hong Kong do it, and we have a regimes operate from the different very strong pre-borrow requirement. But the jurisdictions—was in effect ‘jurisdiction general view of the markets around the world shopping’ by hedge funds and others wishing is, the best way to deal with naked short to short. Are you confident that we can selling is to have very strict settlement actually overcome those in the way IOSCO’s discipline. So effectively you have very strict approaching harmonising the law, and buying in on a short timetable, which makes particularly around the disclosure regimes it economically unviable to take risks with that the different jurisdictions are likely to naked short selling, and that’s quite an adopt? important principle that has come through. MARTIN WHEATLEY The other important principle is the need for Ideally, we need to get not two different a greater degree of reporting and regimes being adopted, but a high level of transparency. I may not get calls in Hong commonality, because an international trader Kong to say, ‘Put them up against a wall and who is trading across 20 markets wants to be shoot them’, but pretty well every week I’ll get able to build a system to comply with the a corporate ring me and say, ‘My price is rules once. going down; it’s the short sellers again’. Because I’ve got data I can usually say, In terms of jurisdiction shopping, we have ‘Well, actually no, it isn’t. It’s people selling a quite an interesting, in fact very interesting, stock; they’re not selling it short.’ People are case study because HSBC is both one of the just selling, and corporates don’t really like to largest-traded counterparties in the Hong hear that, but most of the time that’s the Kong market and also in the London market. truth. But you can’t deliver that message And when London introduced its ban on short unless you’ve got data. selling, Hong Kong kept its existing regime in place. We saw no difference whatsoever in An important part that will come out of this the short selling in Hong Kong of HSBC at debate is the need for a publication regime that time, so it is quite interesting in terms of and a reporting regime. We haven’t defined the empirical data. There was a theory that the detail of it but, as a principle, I think that’s there would be a lot of jurisdiction shopping. something that’s broadly understood now. Our empirical data that we were able to gain And what’s also broadly understood is that showed that actually it didn’t happen in that for certain categories of market activity, you’ll instance. need certain types of exemptions. Global markets, global solutions: the new global financial architecture 107

I can’t talk about other markets. So coming jurisdiction shopping, there’s also other ways back to: can we achieve a common to short. standard? It’s going to be difficult because everybody’s operating to different national I think you have to appreciate—as you look prerogatives. But through IOSCO, we will try to some of these restrictions as to whether it as far as possible to set what we think are is using the CDS market or ATFs (or other the principles—that it should exist—and means like that)—how effective you will be in ideally some more specificity about the rules undertaking various restrictions. that should exist for short selling. Again, in the spirit that Martin articulated, I think

TONY D’ALOISIO regulators fully appreciate the value that short Thank you. Any other comments on short selling plays in our markets—that is, the selling? important functions it provides—and, in terms of price discovery and liquidity, I think if we’re KATHLEEN CASEY balancing those adequately against the data I just agree with everything that Martin has and the analysis that we have, hopefully we said. I think your experience with the various can come up with some common principles, emergency orders that we took both on the certainly on the reporting and publication side. pre-bar requirement earlier in the summer, the additional naked short requirements TONY D’ALOISIO which are still in effect today (including the One of the issues, Martin, that’s been floating hard settlement day requirement), then the around, particularly in the United States, is ban itself, has provided a wealth of the potential reintroduction of the ‘up-tick experience and data for us to operate on in rule’. That doesn’t seem to have got an airing terms of appreciating what the implications in your report. are. I think that’s a really important point. MARTIN WHEATLEY I am encouraged in this area, as much as we Again, Hong Kong has an up-tick rule and can appreciate the opportunities for arbitrage kept it in place throughout this period. that we saw, and if we can at least Particularly in Europe, the up-tick rule becomes appreciate some common principles for how very complex because, under European we might contemplate undertaking legislation, there are now multiple markets restrictions in the future again given our offering the same security. So, what’s the price experience with understanding what the reference point that you take an up-tick rule consequences can be. from? I know we were very encouraged by the data In general, most regulators found it to be too that we have seen, at least on the short complex or legally very difficult to define to selling provisions that we adopted in early implement, so that’s not become part of the September, with regard to the hard IOSCO Task Force recommendations overall. settlement date we saw fails go down significantly. And so there are more targeting TONY D’ALOISIO measures that you can take. I think that’s If we move to credit rating agencies—and we part of the experience that we have taken have covered them quite extensively, but away. Again, I would also note in addition to probably just to focus on differences that may 108 Australian Securities and Investments Commission | ASIC Summer School 2009

be emerging between different jurisdictions— difference arising in how they’re regulated on we work on the basis that there’s a group of the ground. credit rating agencies and a few of them that operate across a range of jurisdictions. Are TONY D’ALOISIO there now differences about the European The IOSCO recommendations at this point approach to credit rating agencies and the have stopped short of any form of international US approach? supervision of credit rating agencies. They lever to each jurisdiction, and through a GREG TANZER process of cooperation between securities In terms of the similarities, and we should agencies of different jurisdictions, to form a start with that, I think both take as their ‘college’ or ‘corporate’ and exchange baseline the IOSCO Code of Conduct information on supervision of credit rating Fundamentals for Credit Rating Agencies, agencies. Is that going to work, is it? Or should which includes a range of rules about we really be looking at a tougher regime of assuring quality about proper disclosure of supervision of credit rating agencies? the information upon which the rating is based, and about ensuring that there’s GREG TANZER monitoring and revision of the methodologies I think it’s an evolving thing. I think it’s that are used as the products themselves relatively recently that a number of the larger change. So all of that is seen as a good developed jurisdictions have been exploring international benchmark. It took some time to and taking on direct regulatory responsibility develop but that was work that has placed us for credit rating agencies. It’s not so long ago in a good position now. that really no one did, except in the emerging markets. The emerging markets for a long Where the Europeans have some time have required registration of credit rating differences—and they are still exploring what agencies. their ultimate outcome will be—is that under their current proposal, they require I do think it will evolve over time. I think we registration of the credit rating agency in need to see how this college of supervisors each European jurisdiction in which it wishes approach would work. Actually, it’s got a very to operate. This does suggest some sort of good chance of working very well because ‘Balkanisation’ (or fragmentation) of all of you have relatively few large global players. this, in that you’ll have credit rating agencies They appear to have an operation that is being forced, if you like, to adopt a different reasonably consistent across the globe and, business model or a different structure so therefore, the sorts of issues that arise they can provide a service in each part of should be similar across the globe. Europe. TONY D’ALOISIO Part of that has to do with a concern about Zarinah, how does it work in Malaysia, and compliance and having a lever, a regulatory how do you see this international lever, there. I think that’s entirely appropriate. arrangement? How they then deal with making sure that this ZARINAH ANWAR is coordinated in an international sense is More than three years ago—as we were something that we’re working hard with them developing the local currency bond market on, because we don’t want to see an actual and, because there is compulsory credit Global markets, global solutions: the new global financial architecture 109

rating required for all the bonds issued, we position is convergence to a global set of found that there were shortcomings in terms accounting standards. This is very important. of the quality of professionalism, in terms of the quality of the ratings—we realised that The current crisis has obviously thrown up there was no oversight really of the credit some issues about the use of fair value rating agencies (CRAs). accounting, especially from the perspective of banks and to a lesser degree insurance We have two local credit rating agencies in companies—for example, there are issues Malaysia, so we decided we had to require around some of the more detailed rules them to register with us in order to gain about mark to market. IOSCO’s been recognition. So we do regulate them in a examining and participating as part of the sense, but one of the main conditions of that IASB’s own internal processes for reviewing recognition is their obligation to comply with all of that. the provisions of the IOSCO code of conduct. At a policy level I must say—and this is really We do exercise vigilant oversight. For much more a sort of personal view here— example, a couple of years ago, one of the there are those who would argue that credit rating agencies had problems with accounting needs to change to take account resourcing. Their CEO and management of the crisis and, in my view, that’s partly right team left the agency, and we exercised some and partly not right. I’m sure there are some degree of supervision in terms of the quality aspects of the way either these standards of the people that they were bringing in. work, or they have been thought to work, that CRAs are also required to publish the credit have led to people taking too strict a view of rating methodology. what a market price is—seeing a particular bid in the market, then deciding that has to TONY D’ALOISIO be the market price and marking down Greg, just briefly, what’s IOSCO’s role in assets accordingly. terms of fair value accounting and so on, the sorts of issues that Kathleen mentioned that But at the heart of it, I think the key issue with the SEC has been working on. What’s accounting is what you see the financial IOSCO’s role on the current debate? statements setting out to achieve. Are they meant to be a snapshot at a point in time GREG TANZER based on at least reasonably objective and Some years ago, IOSCO, as a group of understandable criteria of the financial international regulators, endorsed the position of the company? Or are they meant approach of convergence toward a global set to be forward-looking and projecting what of accounting standards. The financial might be the outcome into the future? reporting standards developed by the International Accounting Standards Board My personal view, when I think about looking (IASB) are now accepted in various parts of into the future—and I don’t feel very the world. They’re accepted in Europe and comfortable about doing that—I certainly the US SEC has a road map for considering wouldn’t be comfortable trusting that to their use within the United States over the accountants. I’m not comfortable trusting it to next couple of years. So the first policy myself. So for me, it’s a little overblown in terms of what accounting can achieve about 110 Australian Securities and Investments Commission | ASIC Summer School 2009

what the future might hold for a financial accounting process is a little bit of a institution. microcosm of the whole of regulation here. You know, how much do you prescribe in The opportunity, I think, from a securities rules and how much do you leave open to regulation viewpoint, is that there’s more terms? readiness amongst prudential regulators and banks and institutions to be much more I must say, personally, I come down on the transparent about what the risks are that they side of rules in accounting. I actually don’t have, that they are holding. Whether that mind too many rules. I kind of understand gets reflected strictly in accounting and that it’s a fairly precise art as long as people saying, this is what my true financial position understand the detail of all of that. I would err is at this point in time, or whether it’s on the side of a bit more precision about something you should reflect in some other what comes out of the other end and people way by some management discussion can make their adjustments if they don’t analysis, some sort of reserving, whatever, agree with the particular rule that’s there, I think that’s the issue we might see agitated rather than too much subjectivity being built over the next little while. in. That’s a personal view.

TONY D’ALOISIO KATHLEEN CASEY We have got time—I know we’re close to Tony, earlier last year the SEC undertook to time—some questions from the floor, please. have a special advisory committee look at the issue of complexity in accounting and Question 3 financial reporting more generally. There One of the issues that keeps on being were several recommendations made that I contemplated throughout this process is the think would go a long way to try to get that need for greater transparency, the need for balance right and, in particular, there were the accounting standards to perhaps disclose questions about issues of materiality and an more. Yet at the same time, we continuously appropriate professional judgement hear comments about accounting standards framework, trying to provide greater guidance being too complex, there being too much and then again ways to improve financial disclosure and, as a result, unsophisticated presentation. consumers (in particular) are being confused. Do you think there is a contradiction there? Again, my hope is that the work of this advisory committee, which was balanced over GREG TANZER a variety of different stakeholders, could be There’s certainly a balance. Yes, you do hear something that the SEC could undertake to sometimes that it’s an issue about what the consider in the coming year. There have been unsophisticated consumer might be able to debates about whether IFRS (International read into the accounting statements. But I Financial Reporting Standards) and US GAAP must say, I think it’s much more an issue of (General Accepted Accounting Principles) what the professional analysts read into suffer from the same challenges of complexity. financial statements, more than just the But I think there is room for improvement there individual consumer. and we have some very good recommendations that I think would be helpful On the issue of complexity, though, I think to addressing that concern. there is a reasonable issue there and the Global markets, global solutions: the new global financial architecture 111

TONY D’ALOISIO At the moment, our focus is all on safety and Thank you. I’m going to need to draw it to a stability. We need to return to an close. Before I do, I’ll ask the panel one more environment where people understand that question. At the end of one of the sessions they’re taking risks. But the real challenge in yesterday, we asked the panel members to the normal regulatory philosophy is we do tell us what was the one thing they would rely very heavily on investors to make their want the G20 to could concentrate on. You own decisions based on disclosure. And, will recall the panel generally agreed around frankly, my confidence about the ability of the solvency issue. So I will ask our panel the people to do that has been shaken through same thing: if there’s one regulatory issue this crisis, given the judgements that some you could have the G20 concentrate on— very professional people were making. we have covered a range of issues this morning—what would that issue be? Martin? KATHLEEN CASEY Actually, I ultimately make the same point, but I MARTIN WHEATLEY think I go back to what was a failure of risk I think—again it’s not specifically from a management across the system. And I think securities regulator—but I think it’s the what’s vital to that is ensuring there are proper reinvention of Basel II that is the biggest incentives for identifying, gauging, analysing, issue. It is partly solvency; it’s partly the pricing and managing risk. One of the key assets that the banks are required to hold. mechanisms that you can use is enhanced transparency or disclosure to do so and I think ZARINAH ANWAR that’s, certainly from the SEC’s perspective, I wouldn’t go into the specifics of the within our purview. Risk management is one of regulation itself, but lessons learned from the tools that will go a long way in trying to previous crises have got to be properly enhance that. learned, understood, shared and applied. When I looked at the IOSCO report in the TONY D’ALOISIO aftermath of the Asian crisis, it sounded a Thank you. I’d like to draw it to a close. I think little bit like déjà vu. Looking at the various what we set out as the objective for this recommendations coming out of that report, session was to start getting into what are very it seems as if we had not learnt the lesson. difficult issues and what the reform agenda So therefore I strongly suggest that lessons that’s shaping up is looking like, both in terms learnt from the crises have to be carefully of specific issues then the broader and more considered and have to be looked at and difficult questions about how you actually effect applied. change in an international system.

GREG TANZER We all recognise that international attention I think perhaps once solvency is returned to to these issues is going to be critical in the system—or confidence about solvency is providing the necessary guidance to each returned to the system—that will be the key jurisdiction. You’ll agree with me that our thing for the G20 initially. I think that there’s a presenters and our panel really stimulated longer term issue about the appropriate role the discussion and focused on what are of disclosure as a regulatory tool and as a clearly, to my mind, the relevant issues. So way of helping investors decide on what sort please join with me in thanking our of risks they’re going to take. presenters and panel. 112 Australian Securities and Investments Commission | ASIC Summer School 2009

TUESDAY The future: a new financial order? Hedge funds: friends or foes?

Mr Kim Ivey, Chairman, Alternative Investment Management Association (AIMA) Australia, and Managing Director, Vertex Capital Management Ltd

For the accompanying PowerPoint presentation, see page 128.

Firstly my thanks to ASIC for being so First, a hedge fund is a managed fund that’s inclusive in this year’s Summer School. trying to deliver an absolute return. It’s not There’s certainly been a lot of discussion trying to deliver a return against a about hedge funds, about some of their benchmark. It’s looking to perform through all strategies, and their behaviour. market cycles to generate a positive return. Second, the hedge fund manager will charge What I thought I would do today is have a a performance fee on this return. No return, dialogue with you about the hedge fund no performance fee. The third attribute is one industry. I may not slaughter as many sacred where there is some debate and that is cows as John Stuckey did yesterday, but I around their capacity to manage a think it will eliminate a few misperceptions constrained level of assets. So hedge funds about the industry. What I’d like to do is talk will generally place a limit on the amount of about some of the complexities that we have assets that they will have under in the hedge fund industry. I’d like to explain management. why those complexities add to misunderstanding. So, if you have those three attributes, you’re generally in a hedge fund: absolute returns, Yesterday, in the workshop, we had a very performance fees, and constrained assets productive session about short selling. We under management. can certainly get on to short selling in this session, but there are some other areas of There’s no doubt we have seen phenomenal mutual interest I would like to spend some growth in our industry. This ‘assets under time on. Peter has brought together a good management’ graph is actually taken from panel here and they will certainly have HFR (Hedge Fund Research, Inc.) research interest in the three areas I will discuss, and you’ll see the drop off at the end of 2008. those being leverage, liquidity and Numbers that I’ve seen recently have taken disclosure. this bar graph even further down. We had phenomenal growth and, with that growth, What do we look for when we look at the come some problems, I think, in the industry. hedge fund industry? Here is a graph of the We have had certainly a shake-out in the last hedge fund growth in assets and it’s split three or four months. between single managers and funds of hedge funds. Let me just pause there to give This second slide colour codes the best you a very brief description of three attributes hedge fund strategies from best to worst over of a hedge fund so that we can start from a the past 10 years. Please don’t try and read common base of understanding. every single box here. I just wanted to put Hedge funds: friends or foes? 113

this up quickly to give you an idea of the 2007. The majority of them were based in many different strategies in the hedge fund London, Europe and New York. industry. Earlier I gave you an overall Here in Australia, the latest databases that description of the attributes of hedge funds I’ve seen show that about 200 funds are now but investment strategies in the industry are being sold into Australia. In terms of hedge extremely complex. These boxes and these fund managers domiciled in Australia, we colours represent the 10 general strategies have about 60 to 65 managers. Overseas of hedge funds. Inside these boxes, there are managers are coming into Australia and even more sub-strategies. offering their products, but they may well be The distribution of returns across these operating in different jurisdictions, have strategies is immense. You’ll have some different regulatory rules, and have different strategies that may be down 10% or 20% in investment guidelines from the same type of the year, while some strategies are up 20%. hedge fund manager in Australia. But the Even inside some of those strategy boxes investor landscape for Australian hedge you’ll have skilful managers generating good funds is extremely global. returns and non-skilful managers generating You’ll find that many hedge funds here in negative returns. So when we talk about the Australia are like my firm when one looks at hedge fund industry, there are many parts to their investor base. When we first started out, it. It’s a heterogeneous set of strategies we were looking at Australian investors, but managed across the world in very diverse by the time we hit our capacity in assets, we fashions. You cannot box the term ‘hedge were managing much more money from fund’ into one nice homogenous category. overseas investors than we were from local Eighteen years ago, as asset consultants, investors. a younger David Hartley and I used to It is not unusual to find a hedge fund based traverse the country trying to teach traditional here in Australia that will be managing asset managers how to be specialist asset money for a Hong Kong Fund of Fund, a managers and understand the specific Swiss private bank, an insurance company in investment mandates we wanted them to London, a family office in Chicago and undertake. Today, balanced, growth, perhaps large investors in Greenwich, CT. defensive, large cap, small cap….these sorts So Australian hedge fund managers are of strategies are understood by most certainly on the world map. We have one of investors in the traditional world. But the largest hedge fund industries in Asia. investors in the hedge fund sector are finding investment strategies less well known and, So what went wrong? Why are we talking as a consequence, more complex. about hedge funds as friends or foes? What’s happened in 2008? You’ll see in this graph, This is a graph that I’ve taken from the Bank which I have borrowed from an excellent for International Settlements (BIS) and HFR. analyst at UBS, Alex Ineichen, that near $30 It essentially just looks at where hedge funds trillion has been lost in global equity markets. are located. That brown-shaded area there It also shows some of the monetary costs of represents all hedge funds. There were world wars, and what they would be in 2008. about 10,000 hedge funds towards the end of Hedge fund losses in 2008 are estimated at around $374 billion. 114 Australian Securities and Investments Commission | ASIC Summer School 2009

I sat in on some of the earlier sessions and their hedge funds if they performed as poorly I heard a lot about the causes of the global as the indexes reflect. financial crisis. Yes, there were hedge funds in this crisis, but they were nowhere near Here in Australia, 20% of the Australian being the source of this crisis. You’ll notice hedge funds actually had a positive return in there is no bar in this graph for a hedge fund 2008, but unfortunately we have had others event. When I first started Vertex Capital that have had negative returns that were back in 1998, there was a hedge fund called greater than the market overall. I think this is Long-Term Capital Management that blew up a question for the hedge fund community and causing a great deal of concern. The involves working with investors and the monetary meltdown of LTCM doesn’t even research analysts on what their expectations get a mention these days. are and what can be delivered realistically.

What about some of the problems? This is Let me move on to the three attributes that I getting into the ‘friends or foes’ question. This said will be of mutual interest because these is a graph taken from UBS, some Thompson issues also underlie why hedge funds are research databases and also from Alex causing such polarising views. Some of you Ineichen. It displays performance for various would have read a release from AIMA talking asset classes.4 The hedge fund community, about systemically significant risks. Well, one as an overall measure, did not deliver on of these attributes is one of those risks and people’s aspirations for hedge funds. That that is leverage. was to deliver a total return, an absolute This is a graph, again taken from BIS and positive return during the down cycle in 2008. some of the investment banks that looked at If you go back to that graph, where I showed the asset growth in the hedge fund industry, you the growth in the assets, with so much showing what the capital was in the funds in money attracted to the industry from 2005- aggregate. The graph also shows what the 2007, perhaps it indicates that the risks were overall market positions were in the industry, forgotten by manager and investor alike. and you can see that the leverage deployed AIMA Australia does a survey of (assets versus capital) certainly grew notably superannuation investors here in Australia in 2005, 2006, and 2007. and we ask them to rank the attributes they I think one of the aspects that you should note seek from a hedge fund when they make here is, while this graph shows that average their allocation, and we give them lots of leverage for the hedge fund industry is shown opportunities to talk about whether it’s fees, at three times, many funds do not deploy any or whether it’s returns or whatever. And by leverage. Again, we have this common view far the biggest attribute these superannuation that ALL hedge funds use leverage, which is investors are seeking is diversification and to incorrect. Moreover, the leverage in the hedge try and find that manager and that investment fund industry is nowhere near the leverage that strategy that will not go down with the rest of we see in banks and in insurance companies, their portfolio. Clearly in 2008, those sorts of which is commonly over 20. investors would have been disappointed in Often times, the leverage that is deployed in hedge funds is for arbitrage purposes: finding a 4 A&Q Industry Research (an arm of UBS Global stock or a commodity or any security that you Asset Management) Hedge funds: friends or foes? 115

think will go up, or you think is misvalued provider of credit? Will they always be there? versus another asset. By going long one and Will the credit terms change? short the other you can implement this These liquidity aspects have actually become arbitrage opportunity. Usually, that requires a more important in the last 12 months than in degree of leverage in order to hit your returns. any time that I have seen in the industry. We While industry leverage has come down, it is have seen the providers of credit to hedge certainly a systemic issue and not just for the funds quickly change the terms of their loans. hedge fund industry. If you look across the These credit providers have certainly had board—whether it be from people taking impairments of their own on their balance margin loans, banks buying internally geared sheets but, in changing credit terms, it has assets, companies selling insurance against made the job of managing a complex leveraged derivatives—when markets go portfolio of assets on an absolute return down, the deployment of leverage just basis that much more difficult. magnifies the problem. The last aspect of liquidity that I think people, Having sat on equity desks, having been the particularly here in Australia, are grappling head of risk for large banks, I can tell you with—and this is something as an industry that one of the aspects that I certainly ask association we are looking at very closely— about when I talk to traders and the portfolio is liquidity inside the hedge fund offering. managers, is how much leverage do we have Many investors, I think, have been here? Are you comfortable, and perhaps as unpleasantly surprised about the lack of important, where are we getting the leverage liquidity when they’ve wanted to take their from? investment out.

The next aspect is liquidity and I think this They have the issue of ‘gates’. You can’t take issue has probably galvanised as much your investment out because a manager has debate in Australia as short selling. As a risk this gate that only lets 25% of the investors manager, when I’ve spoken to portfolio out at every quarter or every six months. It managers and traders, there are escalating may well have been in the documentation, it degrees of liquidity risk that I want to be may well have been explained, but I don’t aware of. But I certainly want our managers think many investors thought that this issue to be looking at trading liquidity. It’s about of gates and liquidity was ever going to be finding out whether you’re able to deploy invoked during the time of their investments. your strategy on a trading basis in the We have also seen frozen redemptions particular assets—how much liquidity the where investors—either en masse, singly or market is going to offer you when you want to together—wanted to take their money out of put large amounts of money in, or take large the fund, but were unable to do so. This has amounts of money out. caused an enormous amount of angst and Finance liquidity—sometimes called funding misunderstanding about why these investors liquidity—is where are you getting your cannot take their money out of the fund. For funding from? Are you getting it only from Australian investors that are investing in your prime broker? Are you getting it from a overseas funds, we have the issue of dedicated source? How determined is that bankruptcy, and of litigation. If the fund is frozen, or is being wound up, you are not 116 Australian Securities and Investments Commission | ASIC Summer School 2009

dealing with an Australian counterpart. You Because we are looking at an industry that will be dealing with counterparties overseas has grown very rapidly, we have seen new and that difficulty and complexity is just investors come into the industry who are adding to the problem. used to a set of disclosure, say under a traditional asset manager, and who are Last point I’ll mention is the issue of looking at disclosure in the hedge fund disclosure. I could probably talk for another industry and are not understanding the risks, 20 minutes on disclosure. Disclosure means even if they are adequately disclosed. one thing when we are talking to people and stakeholders in the industry about short So, Peter, I will wrap it up there. I think we have selling and another when we talk about touched on many aspects of the industry. I disclosure in PDSs (Product Disclosure certainly wanted to convey the complexity of Statements). the industry. We are not talking about a homogenous group of managers. The strategies How do you explain complex terms in a PDS are certainly diverse. We are certainly global to a retail investor? There has been an and these three systemic issues of disclosures, enormous body of work on disclosure that’s liquidity and leverage are areas of mutual been put together, not just by AIMA, but also interest about which the hedge fund community by other industry bodies around the world wants a dialogue with regulators and with from IOSCO to BIS. AIMA has provided investors to make sure we all have the same many guidelines. We have provided sorts of expectations. Thank you very much. benchmarks and reports for hedge fund managers and for investors. We have provided due diligence questionnaires to try and bring out what we believe is proper disclosure.

Panel discussion Moderator Dr Peter Boxall AO, Commissioner, ASIC Mr David Hartley, Chief Investment Officer, Sunsuper Pty Ltd Mr Gary Simon, Head of Investments Group, Global Markets, ABN AMRO Australia Ltd

DAVID HARTLEY the competitive edges that they’ve been able Thanks for that, Kim. When people talk about to identify and maintain. investment markets they often talk about them almost as if there’s a market animal out So I think it is fair to say that, over the longer there, who is living and breathing. term, evolution could be said to be efficient. I think over the very long term, it’s probably Biologists would say to us that over the very fair to say also that markets are very efficient. long term, evolution is very efficient as One of the things that you need in order to unsuited organisms get weeded out. More get that efficiency is to have investors acting suited organisms take advantage of to identify opportunities and take advantage opportunities in the environment and exploit of them. Hedge funds: friends or foes? 117

I think this is one of the things that hedge The other thing I’d say is hedge funds help to funds can do. Hedge funds can assist in uncover substantial corporate issues more market efficiency. People who are running quickly. I think it’s fair to say that there are hedge funds can identify opportunities and issues in the world economy—take Enron, for take advantage of them—for example, by example—that would not have been resolved conducting an intelligent examination of the or not identified as quickly had it not been for underlying exposures of an instrument and people in there who are taking advantage of seeking to take advantage of the fact that these opportunities. these exposures might be mispriced in different areas. At Sunsuper itself, like a large number of superannuation funds, we do have some An example of that would be a credit hedge fund exposure. Last year, about 20% instrument that might be AAA-rated or AA— of the funds in the market made money and there’s not too many AAAs any more, so 80% of the funds probably didn’t make maybe BBB these days—being offered in the money—I guess that’s the mathematics—or United States market, and an offering of the some might have been zero. same sort of credit instrument in the UK market. It may be that someone can identify Last year, our total aggregate result was that those two instruments are being pretty close to zero in our hedge fund mispriced, they can buy one, sell the other, portfolio. Within that, our biggest hedge fund go short one, buy the other one and take exposure had a fantastic year. For example, advantage of that, so that it will lead to our largest hedge fund exposure in the spreads coming back in. That’s what you’d month of September—when, as you know, expect to have in an efficient market. There’s there was a big meltdown—made a 10% no real reason why you should have that big positive return, and in the month of October, difference across different markets. it made a 7.5% positive return.

Another example would be convertible notes. One of the good things about that manager When you break them up into constituent was he came to us in November and said, parts, you’ve got a bond plus an equity ‘You know, we think you should take some option. You could sell one, buy the other. profits’, and so we did. We put in a Another example is the short side research redemption request and got our money back that hedge fund managers use to sell the within 14 days. So that was an example of a stock that they don’t hold, but where most of good relationship with a hedge fund manager the research in the marketplace is biased to and one about which we were very happy. the long side, so there are opportunities there We did have some fund of hedge fund that have been taken advantage of. exposures that Kim was talking about. We So the good part of this, and where the had some of those in the early part of 2008 hedge funds are certainly friendly to the and we also got rid of those in the early part markets, is increasing the liquidity, increasing of 2008 and were quite happy to have done the efficiency and thereby also reducing so. If you look at our hedge fund portfolio transaction costs. This enables people, over the very long term, basically it’s been participants in the market, to get a very much more efficient result. 118 Australian Securities and Investments Commission | ASIC Summer School 2009

pretty much a zero-beta portfolio.5 It hasn’t priced, so what they did is they took a short really had too much correlation with the position in junk bonds and a long position in markets. That’s where hedge funds have the senior credit. You would have thought been very favourable. that, in a case of default, that’s going to be okay. In fact, what happened was the prime Where might hedge funds not be so broker pulled the plug on that particular trade favourable? I think the main cause of and that fund went under; it was closed concern with hedge funds is when they down. themselves become the cause of inefficiency and, instead of being there trying to identify Another thing we have seen is there’s a little these opportunities and correct them, the bit of hedge fund envy or fee envy. We had a hedge funds themselves become market long-only manager who had a very good makers. track record, and they came to us with an opportunity. They said, ‘We can buy these We have seen some examples of that—take instruments for you in the portfolio, but what the excessive leverage of some hedge funds. we want to do is set up another fund. And, Kim said that, in the average fund, leverage instead of charging you 25 basis points for is not that high and that’s quite true. But fees, we want to set up this other fund, which there were some particular positions that we want you to pay a 2% fee on.’ I said to were being followed in the marketplace. them, ‘But this is stuff you can buy over here. One of the outcomes of that was that credit Have you bought that in the portfolio?’ They spreads became very, very low—I think said, ‘No, we haven’t yet, we wanted to.’ So I unsustainably low. Basically people were just said, ‘Come and have a chat to me after saying to us, ‘We don’t need your equity for you’ve filled up the portfolio with that stuff. these private equity transactions because Then we will have a talk about what else we we can go and get debt finance very cheaply can do.’ But basically they didn’t come back somewhere else’. That was an interesting after that. case in point. One of the observations I’ve made about Another place where hedge funds don’t do investment markets over a fairly long time any favours for the market is where people now—as Kim said, when we were pups—is start to take short positions then feed the that there are very clear cycles that the rumour mills. I think people have been talking market goes through. And when I think about about that before, but that’s something that this I think about the ‘yin and yang’ symbol. the regulators really should be looking at, and probably getting those people in gaol. I don’t know whether you know about the yin and yang symbol, which represents two Another thing that we have seen is unstable competing elements in a cyclical relationship. prime broker relationships. For example, I When one element is at its maximum, it’s know of one hedge fund in the United States sowing the seeds of its own decline. And that had quite a reasonable position. They that’s sort of the overall thing that you see thought that credit spreads were too low, countless examples of in the investment they thought that junk bonds were too highly markets.

5 A portfolio designed to represent the risk-free asset (i.e. having a beta of zero). Hedge funds: friends or foes? 119

For example, we had the ‘tech’ bubble—that people are looking at those investments, was a crazy time in the late 1990s—when, they’re setting themselves up for a very unless you were losing money, the market dangerous situation. view was you’re not worth buying because you’re not investing for the future. So the We did have some fund of hedge funds, companies that were losing the most money which we got out of. I think that in the case of were the ones that had their prices go up the fund of hedge funds, the fees that were being most. That was just stupid. charged were very, very high, relative to what they were adding. Another thing that we have At the same time, we had resource stocks in noticed is a lot of private equity style Australia—for example, goldminers like exposure has crept into hedge funds. People Newcrest—that were trading at a particular are not really very clear on what they’re price. If you looked at the value of their cash trying to do, so they’ve gone into investments and at the value of their hedge contracts and that they shouldn’t have. you added those up, you basically got to the share price, so the gold mines were free. So, looking forward, hedge funds can be very Those sorts of things happen all the time. useful and have been very useful in the past. This is the kind of environment where you’re Indexing is another one. If indexing gets probably going to have a lot of good long-term popular, then basically you lose your price relationships developing—you know, for discovery mechanism. A common theme is example, a manager telling you that you should that when investments elements are at their take some profits. maximum, people who shouldn’t really be there are being sucked in at the wrong time. The regulators have a fantastic opportunity They overextend, and then the subsequent with hedge funds. What I mean is that, in this sales process can be very extreme. current environment, the regulators are going to be able to get a great source of I think what we see—and, in fact, I think we information. They’re going to get a lot of have seen it quite a lot over the last couple of people doing a lot of work for them. So if the years—is people trying to mimic (almost in regulators can get some transparency, the biological sense) what the hedge funds particularly on things like market short are trying to do and setting themselves up positions, and use that to examine the over here—trying to get those fees, trying to companies a little bit more closely for things mimic them—but they’re not as nimble. like corporate weakness or malfeasance, I They’re basically setting themselves up for a think they can probably get quite good results big fall. looking forward. Thank you.

One of the hedge fund concerns that we GARY SIMON have is the liquidity aspect that Kim was Good morning everyone. Thanks, David. talking about, especially for the highly geared structures. They can be really, really smart David obviously has had a very wide array of ideas and they might pay off over the very experience across the market over many long term, but the problem is that the market, years. At ABN AMRO, our main focus in the the prime brokers and the banks basically funds world is in the area of social don’t have that sort of time period. So when infrastructure, which really is a long way away from the hedge fund world. 120 Australian Securities and Investments Commission | ASIC Summer School 2009

However, over the last 18 months, we have manage out the portfolio for a fund that had some quite relevant experience in one ended in termination. specific sector of the hedge fund world and I’d like to drill into that and recount some of So, what have been the major takeouts from that experience this morning. that experience? Was this business a friend or foe, and what was its experience with Before I do, I just wanted to talk about a other similar funds into which it invested? I’ve recent visit to McDonalds. Now, it’s a long got to say, in looking back over those 18 time since I frequented a McDonalds, but I months, I support the view, which has been was recently driving back from a weekend at expressed through this conference, that the Lake Macquarie, feeling a bit hungry and basic principle of dissemination of risk is there it was on the expressway, those great healthy. big golden arches. Now, I used to be a real fan of the sundae with chocolate sauce so, Banks are natural originators of assets but along with the Big Mac, I ordered a chocolate are capital constrained due to Basel I and sundae, and in a moment of impetuousness now Basel II. Pension funds and individual I asked for extra chocolate. investors are natural holders of risk, providing that it’s properly priced and It occurs to me that the hedge fund world is understood and appropriate to their portfolio. a little like the ice cream under the chocolate But a bit like the chocolate sauce on the sauce. Now, I’m not saying that the McDonalds’ sundae, too much of a good McDonalds’ sundae is everyone’s prime thing can make you ill. health food, but what in some circumstances can be a friend, can have some very As we have seen in other commentary during unpleasant consequences when one yesterday’s session, risk was leveraged and overdoses on part of the package. releveraged, fees taken out. Credit spreads, as David mentioned earlier, narrowed to When talking about hedge funds, much of the inappropriate levels and so—as a market is focused on equity funds. However, consequence—leverage was poured into the concept of a hedge fund, as Kim said improved returns. earlier, is any fund targeting an absolute return. So it can also include a variety of In addition, when difficulties arise, the various structured credit funds and that’s where we structures utilised in this disintermediation of got involved. risk have limited flexibility for everyone, and that’s been a major problem that we have In late 2007, ABN AMRO took on a role to experienced in trying to maximise value in manage a portfolio of structured credit this portfolio. But consequently, when there is assets. The fund manager in question had a failure in one sector, the impact could no collapsed. The final washout of a fairly longer be limited to the lenders to that sector difficult period was that a new responsible since risk has been so widely disseminated entity was appointed, a service supplier to and leveraged. Ultimately, confidence failed provide fund administration services was and so we are where we are today. appointed, and ABN AMRO hired a small number of the previous investment team to The fund that we took on to manage was in the middle of this food chain. It specialised in selecting underlying portfolio managers and Hedge funds: friends or foes? 121

maintaining a well-diversified portfolio. The and the issuers of risk. We end up with what portfolio had less than 1%—in fact, I think it we call the ‘agency problem’, when the was around 0.74%—maximum exposure to intermediary has an asymmetric risk. You any one name, in a balanced and diversified both get rich together but the principal takes portfolio across industry and geography. the vast majority of pain. Notwithstanding that diversification, the repricing of the entire sector and the lack of The level of disintermediation of credit has liquidity together have had a major negative meant that the conventional portfolio theory impact on the portfolio. and diversification was not sufficient to maintain confidence. Accounting standards So, in my view, the friend is certainly an are starting to drive behaviours that do not industry through which wide dissemination of permit the most sensible commercial risk allowed credit to become more available outcome to occur. This is not just in fair value to support economic growth, help lower the accounting, but also in consolidation rules. cost of borrowing. The foe was, simply put, Hence, any review of market practices in too much of a good thing. Basel II must recognise that Basel starts with the balance sheet and accounting standards So what next? Well, banks are still capital shape the balance sheet. constrained, indeed much more so than ever before, but the underlying principle of banks Earlier today, a former accounting colleague as originators, and pension funds and others of mine reminded me that we don’t want to as natural long-term investors, is turn the clock back to Enron days and the fundamental to our system. The market will masters of balance sheet accounting. But self-correct in respect to overaggressive there is a balance somewhere in the middle. structures. You only need to ask anyone trying to sell a leveraged asset at present. So rather than more regulation in my view we They will testify to that. need structures where originators can retain some ‘skin in the game’ in a way that is not One of the key issues, which did not receive complicated by accounting standards, then much attention in yesterday’s session, is the allow the market to develop new structures interplay of accounting standards and Basel that allow investors to regain their II. It started to get a bit of an airing this confidence. morning. In my view, accounting standards have started to drive practices and Hedge funds are a very, very wide group of transaction structures. Accounting standards people and styles of investing, but with some force originators to sell all of the risk and sensibly thought around practices and reward out of fear of consolidation and the structures, hedge funds can be a friend to the flow-on impact on risk weighting of assets. market and the only foe is the mug who orders some extra chocolate sauce. As a consequence, there arises a significant Thank you. disconnection between the owners of risk 122 Australian Securities and Investments Commission | ASIC Summer School 2009

Questions from the audience (names withheld)

PETER BOXALL Australia have to meet all the compliance Thank you. That will give plenty of food for standards already, so what is the extra— questions from the floor. A couple of issues what’s the extra chocolate sauce—that we we’d like to cover are, is there a need for could put on disclosure? I think that is closer regulation and or greater disclosure of systemically risky positions and the degree of the hedge fund sector? Also, have hedge leverage. But I think it opens up the door for funds amplified or moderated the market the dialogue with the regulators to find out downturn? Any questions. how do you do it and what other aspects, apart from leverage, should be disclosed. Question 1 The question relates to the issue of PETER BOXALL disclosure that has come up already. I think David, do you want to add anything? Kim focused on initial disclosure of hedge funds offering documents, whereas David DAVID HARTLEY Hartley mentioned disclosure of short selling, I don’t think I can add too much to that. When for example, by hedge funds. What about the I look at the types of instruments and the types recent AIMA initiative that was announced in of transactions that have been put in place I London for regular reporting and increased think certainly something that has got a transparency of systemically significant capacity to significantly damage needs to be positions and risk exposures by managers of disclosed. When people buy more than 5% of large hedge funds to the national regulators? a company, for example, they have to disclose that they hold more than 5%, so it’s probably Just wondering if the panel has any fair that they also disclose when they hold short comments on that? positions that are significant, for example.

PETER BOXALL When I think about the debate around Would you like to have a go at that, Kim? regulation, I think the key groups that need to be regulated are the fundamental providers of KIM IVEY liquidity in the market—that is, the banking This policy was put out last week. AIMA system. I think to try and broaden that net too has been in discussions with a number of widely would create a massive bureaucracy, but regulators and expressed in that I think the market will deal with that providing announcement a desire to find some there’s appropriate disclosure. I’d agree with harmony in disclosures. Because what we the comments of the other panellists. have right now certainly is a different set of disclosures in Australia from what is done in PETER BOXALL Asia, and we are working on it in North Okay, thank you. Another question? America and in Europe. Question 2 Personally, I think—and certainly the industry You’ve mentioned regulation by securities body believes—that disclosure of regulators. There’s a debate going on inter- systemically risky positions is prudent. In nationally about whether any hedge funds Australia, hedge funds come under the are of a size or a scale or a level of inter- purview of ASIC. Hedge funds that operate in connectedness that some sort of prudential- Hedge funds: friends or foes? 123

style regulation would be relevant. I’d be PETER BOXALL interested in comments on that. There was mention made of the unstable prime broker relationship being a point of KIM IVEY vulnerability. David? Size and scale, I guess, are two aspects that you have to compare to the behaviour, size DAVID HARTLEY and scale of the markets in which they It certainly is a point of vulnerability and I operate. Clearly, if you have very large think also that it was probably affected by the investors, whether they are hedge funds or total meltdown at the time. One of the things traditional managers, operating, say, in the that happened in the past is that some of the small cap universe, then their impact is going hedge funds have been totally dependent on to be disproportionate perhaps because one prime broker. When that prime broker there just aren’t enough opportunities in decides that they don’t want to support that which to invest. particular hedge fund any more, then it is ‘all over red rover’. The issue of prudential regulation is very interesting because we have a prudential In the particular case I was referring to before— regulator here in Australia for superannuation the short junk bonds and long senior credit— funds. We have had some very frank those positions were actually picked up by discussions with APRA (Australian Prudential another hedge fund, which is interesting in itself. Regulation Authority), certainly back in 2003– 04, where there were moves to try and PETER BOXALL prescribe or ‘carve out’ certain types of Has that changed now? Is there more hedge fund strategies. diversified use of prime brokers by hedge funds? What we really want is to put the onus back on to the hedge fund community to say, DAVID HARTLEY ‘Listen, if you are trying to manage pension Kim is probably better to talk about that, but assets and life term savings, there is an onus I suspect they’re probably a little bit more on you to be able to prove to the trustees of circumspect about the sorts of relationships these funds exactly where you fit, in a they’ve got with prime brokers. prudential way, into their portfolio’. So I think KIM IVEY there are avenues for that, but as ex- There certainly is a move to use multiple Chairman Volcker said recently in a speech, prime brokers. The use of multiple prime you don’t want regulators to be regulating brokers was actually discouraged after Long- every single little hedge fund in the world. Term Capital Management (LTCM), because Question 3 it was found that LTCM had multiple I’d be interested to hear about how the positions with the prime brokers, but no one relationship between prime brokers and actually knew what the aggregated risks hedge funds has been impacted by the crisis were. So, I’ve avoided the use of the word and how it might evolve going forward. ‘transparency’ in my presentation, because it does mean so many different things. But certainly, when you are talking about risk positions between your counterparty and 124 Australian Securities and Investments Commission | ASIC Summer School 2009

provider of credit and yourself as a manager, was happening in the hedge funds. That’s my you want transparency there. feel.

You want to be able to look across all the PETER BOXALL prime brokers, but there is definitely a move, Thank you, Gary. because of the withdrawal of credit, to go to multiple prime brokers. We had a very large, KIM IVEY iconic hedge fund last year go out to public There’s a more general observation here. markets and actually raise money via a bond. I think over the last decade, we have seen They got a rating and went out and got a world economies promoting globalisation as dedicated line of credit via bonds so they had a source of economic growth and, in the that permanent line of credit, and I think that same way that globalisation is designed to will continue. And I think that will be a good drive growth upwards, it’s probably move certainly for the hedge fund managers accentuated the swing downward as well. that they will be able to say, ‘We have this And it’s meant that something that was no permanent line of credit. We are going longer isolated to a single economy is spread directly to investors, we are not going through the whole world. through an intermediary via the prime This might sound a bit simplistic, but technology brokers.’ has changed enormously in the last 15 years The prime brokers understand this as well and and the impact of digital communication coupled are working with the managers about their with that push towards globalisation, I think concerns. that’s something that needs to be looked at, rather than regulation. I think people looking at PETER BOXALL the system have got to look at the impact of the Yesterday morning, there seemed to be quite digital communication age and the impact that a consensus that hedge funds weren’t the has had on transparency, disclosure, and all of cause of the global financial crisis and I those sorts of issues. guess a question that has emerged is that, given the very nature of hedge funds, are GARY SIMON they likely to amplify or moderate the I don’t really have too much to add. Hedge situation where you have a large financial funds are certainly opportunistic. I think shock? Any comments on that? David brought up an excellent example about the dialogue that exists between investors GARY SIMON and hedge funds. If there are no I think there were plenty of opportunities that opportunities there, you may want to arose because of what was happening in the consider taking your money back. If there are markets, and if the hedge funds had had the opportunities there, well, I think the classic capacity, I think they would have been in example is a hedge fund manager called there dampening that volatility. I think the Paulson where he saw an opportunity in problem was more long-only investors who mortgage markets in the US and went out had borrowed money—on margin loans and and raised quite a bit of money, because of things like that. I think probably the forced the opportunities that he saw. It turned out to sales there were more dominant than what be a very productive investment. Hedge funds: friends or foes? 125

There’s a great opportunity for hedge funds particular parts of the hedge fund industry data at the moment because there’s a lot of that should be disclosed, although not mispriced credit assets out there. If you do necessarily publicly. But certainly, the regulators the underlying analysis, they should pay back are looking at systemic issues. There should be, at par at maturity and they’re being priced at I think, hard guidelines and hedge funds of their 20 or 30 cents, so one could argue that own volition should be able to say, ‘We want to hedge funds—given the arbitrage opportunity participate in this measurement because it’s in there—could be soaking up and driving some the best interests of everyone, all the normalcy back into the market. But it’s stakeholders in the industry’. So I think there are actually not happening. pockets that should be disclosed and will be disclosed going forward. PETER BOXALL Okay. Question down here. DAVID HARTLEY I think it also depends on what you want to Question 4 do with the data. When private equity was in My question is about the data available on a bit of a boom a couple of years ago, we hedge funds. At the moment, the data is spoke with a fund, who at that stage were the collected from hedge funds by organisations biggest pension fund in the world. I don’t on a voluntary basis and that has think they are any more. implications for the quality of the data because there’s incentives for hedge funds One of the things they mentioned to us was that that are doing well to report their data and for they didn’t think that large leveraged buyouts ones that aren’t doing so well to stop were things that were going to create a lot of reporting. I wondered if you had an opinion value, but nevertheless they were still buying about whether the quality of data should be them. We said, ‘Well, why are you buying improved, how you might go about improving them?’ and they said, ‘Well, they’re part of the it and whether there should be perhaps index, they’re part of the benchmark. ‘ mandatory reporting of data by all hedge funds to improve the quality? So I think it depends on what the data is going to be used for. If it’s going to start to KIM IVEY drive investor behaviour into investing into I guess the question is the difference bubbles in the hedge fund markets, then I between hedge fund data and the traditional think it’s a little bit dangerous. Like a lot of asset management data. No one is forcing other things, it has to be viewed with the right traditional asset managers necessarily to tell pair of glasses. everyone what their positions are, but I think the rationale and the reason goes back to KIM IVEY systemic issues in having the data and As a follow-up, about the data in particular, having it reported, so you can find out with the RBA (Reserve Bank of Australia) whether there are some systemic pressures now wanting to gather data on stock lending in there that have been built up in the and looking at the custodians, the question is industry. why? If you want to avoid problems that we have had in settlement—stock loans, the I think rather than try and regulate, AIMA is Tricom issues, the Opes Primes—great. certainly trying to move towards looking at That’s certainly a very pertinent reason. But if 126 Australian Securities and Investments Commission | ASIC Summer School 2009

you’re trying to find areas that lead into short the hedge funds, these large hedge funds, selling, well, I would suggest measure short are becoming quasi-investment banks. And if selling. Don’t measure stock loans/stock you want to go down that route, you have to lending, because you’re going to find this recognise that we’re not a cottage industry dichotomy and it is going to be misleading. anymore, but you are going firmly into the So what we should be doing is finding a light of regulators. Don’t complain about that; proper way, and a valued way, to get where understand that where you’re going needs those pressures points are in short selling regulatory purview. and how much a particular company stock is being shorted, rather than trying to come DAVID HARTLEY back to maybe a vague aspect of that via a I think there are a number of investment stock loan procedure. banks that, if you look at their proprietary trading activity historically anyway—probably PETER BOXALL not too much just recently—you would say Okay, time for one last question. that to some extent they’ve got a portfolio of hedge funds sitting inside them. And, to the Question 5 (Adrian Blundell-Wignall) point, we have one hedge fund manager who Adrian Blundell-Wignall from the OECD. This came to us offering a great deal, he was is a question for Kim. I might have misheard effectively taking a trading strategy he used you, but I thought you said, it’s a great thing to use in a proprietary situation in a bank and that hedge funds can start tapping the capital was now offering it around. His fee markets directly. If I misinterpreted you, then expectations were a bit high too. He wanted that’s fine. But the question I guess is, isn’t it to take 80% of the alpha. He thought that precisely the issue about regulation that if a was a good deal—for him, I think. hedge fund starts issuing securities in its own name, starts making markets in derivatives, As I said, I think that the hedge funds play a hiring dealing desks and so on and so forth, useful role in the markets. When you invest that it basically becomes an investment in them, I think you just have to be careful bank? So if it walks like a bank, sounds like about what you’re investing in. I think the a bank, it probably is a bank. Isn’t that alignment of interest is something that I exactly what takes it into the regulatory net haven’t mentioned before. It is critical when as opposed to simple things like registration you’re investing with a hedge fund that you and so on? make sure that the person you’re investing with has major ‘skin in the game’, because KIM IVEY otherwise, it’s just someone else’s problem The point I was making regarding debt and all the time. the provision of credit is going directly to the market to obtain debt and having those So that alignment is important and I think disclosures around debt and I don’t think this hedge fund managers now are more willing is a bad thing. I don’t think it’s a bad thing for to talk about their strategies and the sorts of investors. And, Adrian, I think in making the things they’re doing. They’re more willing to point of, where do you go from there, I think have a good relationship with their investors. it’s very valid because there is discussion That’s the sort of thing I was talking about going on amongst the regulators, amongst before. So I think what’s happening now is a the community, about the fact that some of bit of a cleanout. Some people who should Hedge funds: friends or foes? 127

have never been in the industry are getting We fully supported the regulator in trying to cleaned out and I think it’s probably going to find out information about the market be healthier in the long term. manipulation and short selling. But when you look at the information that hedge fund PETER BOXALL managers are providing—whether they’re Kim? Any final comments? talking to institutional investors or they’re disclosing their short sort of positions—that KIM IVEY information is valuable and you can make up I didn’t perhaps answer the question in my your mind whether they’re operating as a presentation about hedge funds: friends or friend or foe. foes? Certainly, I think there are aspects of what hedge funds do that leave people GARY SIMON wondering what the rationale is and what the I think David’s point about alignment of end game is. interest is very important, and I’m a strong believer in that. I’d just like to revisit the point I’d just like to touch on one part of the hedge I made about accounting standards. There fund strategy and that is short selling. We are some circumstances, but not all, where operate in an information business, this the shift to tighten accounting standards is investment business, and I would commend actually working against achieving that everyone to think about some of the alignment of interest, and I just think that’s information that is being portrayed. something that needs to be thought about in When you start seeing short sellers, look at this current debate. the companies, are they a friend or are they PETER BOXALL a foe? Well, they’re providing information, I Thank you very much. We have a wealth of think, that’s very valuable information on why experience up here and it was a very good they are selling the company shares short. session. Thank you very much, Kim, David You make up your mind. and Gary.

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TUESDAY The future: a new financial order? Structured products: how will we deal with them in the new financial markets?

Mr Greg Medcraft, Commissioner, ASIC (previously Executive Director and Chief Executive Officer, Australian Securitisation Forum, Global Head, Securitisation at the Société Générale)

For the accompanying PowerPoint presentation, see page 148.

Panel discussion Moderator Mr Michael Dwyer, Commissioner, ASIC Mr Robert Camillieri, Senior Manager, Credit, Aviva Investors Australia Ltd Mr Ben McCarthy, Managing Director, Fitch Ratings Australia Pty Ltd Mr Gary Sly, Director, Debt Capital Markets, Global Markets, ANZ Banking Group Ltd Mr Andrew Twyford, General Manager, Treasury and Securitisation, Challenger Financial Services Group Ltd

MICHAEL DWYER This afternoon’s session is about structured Did capacity to innovate financial products products: how will we deal with them in the outstride capacity to manage the operational new financial markets? risk of those products? Was there adequate segregation of risk and control functions? This is a really interesting area, and we have Was the compensation of managers aligned brought together today a very experienced with the management of risk, in particular to panel to discuss how we’re going to restore avoid excessive risk taking? confidence in the securitisation markets, both domestically and internationally. Today, ASIC Summer School brings you five eminently qualified industry professionals to The absence of an efficient and functioning answer these and other questions. They will credit market has substantial and potentially also discuss and comment on the response devastating implications for returning to required to restore confidence. economic growth. The current crisis in the securitisation markets requires an immediate First, bringing it all together this afternoon is and coordinated response to restore the arguably the man who put securitisation on confidence of investors and other market the map. Please welcome Greg Medcraft. participants. GREG MEDCRAFT Our panel today will elaborate on why issues The theme of today’s event is ‘The future: for Australia may be different to those in the a new financial order?’ Why is securitisation US. However, a number of questions do important? First of all, in the US market, it arise in relation to the US market. represents 50% of all credit creation. In Structured products: how will we deal with them in the new financial markets? 133

Australia, it also represented a significant road map for what needs to improve in the percentage of mortgage origination. securitisation industry. You’re going to hear about some of these recommendations today But more importantly, why did it evolve? and, while they don’t require any new It evolved because it reduced the cost to regulation or legislation, they do need new consumers of financing and also it increased industry standards to be developed. the availability of funding. So it is quite significant. McKinsey focused on issuer transparency, pricing transparency, rating agency I think now policy makers see it as being part transparency (which we have talked a lot of the solution—that is, in increasing or in about today), and also on education. preserving competition, and also in directing Education is something that I think we need credit creation in the system. So I think it’s to come back to. There’s been some very important for the market to recover in discussion also on global coordination, so I’m terms of confidence. A good market requires just going to move on to the first point, which homogenous products and informed buyers is issuer transparency. and sellers. Some of the themes that we’re going to look at today touch on that in terms The McKinsey report recommended that we of improving the market in this way. increase and enhance the initial and ongoing consolidation of information into a much In terms of regulation, I think it’s very more easily accessible and standardised important that regulators engage with market format. Secondly, that we establish core participants and that’s why this panel today industry wide standards of due diligence and will be very interesting. Australia quality assurance practices for residential (represented by Tony D’Aloisio) and our mortgage securities. Thirdly, that we French counterparts are leading the IOSCO strengthen the representations and Task Force on unregulated financial markets warranties as well as the repurchase and products and they will be looking at, in procedures. And then fourthly, that we particular, securitisation. IOSCO considers develop industry-wide norms for evaluating improvements in market standards to be very service and performance. important, but equally so is having that discussion with market participants. In relation to that, what has actually happened is that America launched a thing Last year, the industry was clearly concerned called Project Restart, which identifies 157 and they engaged McKinsey & Company to fields of information that were agreed to by undertake a worldwide study in which they the industry. In turn, the rating agencies conducted in-depth interviews with over 100 agreed that they would not rate a deal if it issuers, investors, dealers, services and didn’t come with the standard information. credit rating agencies (CRAs).6 In addition, they conducted an online survey around the I will now pass over to Andrew Twyford. world of market participants and elicited 400 Andrew? responses. What they came out with was a ANDREW TWYFORD Thanks, Greg. To touch on the issue of 6 See ‘Restoring Confidence in the Securitization transparency, I think the other element that Markets’, 3 December 2008, at www.americansecuritization.com. Greg’s asked me to talk about today is that 134 Australian Securities and Investments Commission | ASIC Summer School 2009

there’s been a fairly significant push in the So what are some of the key differences global marketplace for issuers to have more there? In the originate-to-sell model, the ‘skin in the game’. I felt the best way to originator of the loan has gone out and sold highlight this was to show some of the the loan. When they sell that loan, they relative strengths or differences between the effectively get the full value of that loan at Australian securitisation market and some of that particular time, so they are out of the those offshore. I will also highlight the game at that point. They’ve been differences between the Australian market remunerated for the origination service that and the US market. they have provided and then that’s passed on to the ultimate securitiser. Whilst luck, from the perspective of where we are in our economic cycle, has not played an In the originate-to-fund model, however, the insignificant part, some of the differences issuer of those securities is held to the between the Australian and the US models performance of the loan throughout its life have been a key driver behind the materially cycle. So we have, as is the case in better performance of Australian securities. Australia, a subordinated party in all of those These differences are examples of where transactions. For example, Challenger only Australia has historically led the way in gets paid the vast majority of its meeting some of the key aspects of the remuneration at the end, or after the McKinsey recommendations. The two main investors have been paid. issues we’re going to cover off today are the issuer model and the loan collateral. So the distinct benefit of the Australian model, therefore, is a much closer alignment Looking at the issuer model, there are of interest between the investor and the basically two models that are in place. The issuer due to the issuer’s position behind the US is probably the best example of the investor in the income flow. Some other ‘originate-to-sell’ model. That’s where the benefits are at securitisation, where the majority of securitisers in the US source issuer is able to provide clearer and more loans from organisations that have originated detailed information—that is, detailed that loan and funded it for a short period of information about exactly how that loan has time. They then sell that loan through to been originated (because we were a party of another entity who will ultimately issue that the process), how the borrower was sourced, into the securitisation market. what information was provided at the time the loan was written, and what the circumstances In Australia we have a different model, which are around that borrower. We have is the ‘originate-to-fund’ model. That’s where completed the full underwriting process and the originator of the loan, and Challenger is can provide all of that detailed information an example of that, will originate the loan and that’s been outlined in the McKinsey manage and service that loan all the way recommendations. Post-securitisation, through to securitisation. It will issue or because we are involved in the process all of securitise that loan off its own platform. It will the way through, again we are subsequently then work with the investors over that period responsible for all of the servicing of the of time, so it will go out and market and sell mortgages, including making sure the that loan to investors. mortgages perform as well as the management of all of the structures. Structured products: how will we deal with them in the new financial markets? 135

We’re also involved in all of the loan the most distressed mortgages that are reporting, which means that we can actually securitised at the moment. The type of get all of that detailed information with agency, or the type of collateral we’re talking knowledge about how that loan has initially about in Australia, is in prime borrowers— been originated. So there’s a lot more benefit that is, non-credit impaired borrowers, lower in that compared to a scenario in the average loan size and lower loan-to-value originate-to-sell model, where there may ratios—all key determinants in the likelihood have been a transfer of that loan on one, two of the borrower being able to continue to pay. or potentially even three occasions before the loan ultimately gets out to the investor. Australian limited documentation lending—or By that time, the ability for that issuer to be ‘low doc’ lending as it’s been known—is a able to provide that level of detail is not as product that was specifically structured in easy as it is in the originate-to-fund model. Australia in the late 1990s for self-employed borrowers. So instead of being a product The other key element in the Australian that’s being distributed to normal ‘pay-as- securitisation industry, which has been of you-go’ borrowers—that is, borrowers who benefit for us, is the loan collateral. receive a pay slip to prove their level of Australian loan collateral benefits from a income—self-employed borrowers are number of key differences and I’m sure a entitled to these low documentation or limited number of you will be familiar with some or documentation loans. all of these. These include full legal recourse to the borrower, which avoids the concept of In Australia, the limited documentation a borrower walking away from their lending is all around self-employed borrowers mortgages, as happened in the US. I’m sure who are running their own businesses, who we have all heard of the term ‘jingle mail’ have less of an opportunity to be able to where borrowers have just basically mailed in provide the depth of data that we require as a their keys to their lender. lender to qualify for a full documentation loan. The lending standards are also driven by strong national consumer protection The risk mitigation that we put in place for regulation, and the Uniform Consumer Credit that limited documentation lending is that Code here in Australia is a key plank to that. Australia has much lower loan-to-valuation Lender’s mortgage insurance is incorporated ratios (LVRs) and these have been capped into all of the transactions that have been generally around the 80% mark in the prime issued by Australian issuers in the prime marketplace. As a result, our limited lending space and that’s a one-off premium documentation loans—again, whilst that’s paid to cover the lender and the performing marginally worse than the full investor for any principal shortfall, including documentation loans at the moment given costs for the life of that mortgage. the economy we’re in, which for self- employed people is quite difficult—are The vast majority of funding in Australia is performing well in comparison to equivalent akin to US ‘agency’ collateral. Agency type of loans in the US and other collateral is the best of the three types of jurisdictions. collateral in the US. In the US it is ‘agency’, ‘Alt-A’ then the subprime, which are clearly 136 Australian Securities and Investments Commission | ASIC Summer School 2009

Also another key plank or difference in the economic position that the Australian market Australian marketplace is the fact that we has been in has resulted in residential only had a very small amount of what we call securitised products in Australia performing in Australia ‘non-conforming’ lending, which exceptionally well, compared to the is more akin to subprime lending in the US. international benchmark. I think that being said, the Australian industry is very cognisant In Australia, non-conforming lending is that we need to continue to work with our generally lending that is outside the colleagues from the other global industry mortgage insurer space, so it is really a associations to ensure the concerns raised in combination of what in the US they call Alt-A the McKinsey report are addressed to ensure and subprime. We only have around about structured products are viable products in the 2% of our market in that non-conforming global capital markets going forward. space, whereas at its peak subprime lending in the US had grown to around 30% of I think the Australian market is well placed to originations. Also, the types of products in continue to be a leader in the capital markets Australia, on average, have elements that and to be able to meet and drive the make them better quality—for example, very transparency required by those global homogenous lending products with a legal markets. life of 25 to 30 years, much longer legal lives than in the US. MICHAEL DWYER Andrew, I guess what we’re hearing from you In the US, they do not have predominantly is that our market is very different structurally variable rate mortgages with no tax to the US market and you’ve given us a lot of deductions for owner-occupied property. So good reasons as to why that is. Potentially, it’s very much a fixed rate product and the we are six months to 12 months behind tax deductions are available to borrowers in what’s happened in the US. Are we going to respect of their owner-occupied property. be sitting here this time next year and coming This means that the borrower acts a little bit up with the same sort of issues, or do you differently. In Australia, there’s no incentive think your reasoning is going to hold the test not to pay off your mortgage as quickly as of time? possible. ANDREW TWYFORD Finally, there are in Australia very limited I think the reasoning about why our market is adjustable rate mortgages or ‘ARMS’ as different will hold the test of time. they’ve been known in the US. In Australia, the adjustable rate mortgage is a mortgage As I said, our economy was in a vastly that steps up after an initial period and is different shape to where the US was at the really a product that’s been predominantly inception of the crisis. Hence, we are in a delivered by the big four banks in Australia to much better position—from house price the first home owner market, where they values and unemployment levels—for might give them a discount of say, 1% in the borrowers to be able to maintain their first 12 months. payments, and loan collateral is going to be able to perform much better in comparison. I think the result of the two points of differentiation combined with the stronger We’re part of the global marketplace, though, so in respect of the securities that have been Structured products: how will we deal with them in the new financial markets? 137

issued, our securities are right in the turmoil GARY SLY of the global marketplace. My starting point would be from a discipline point of view that it’s the same, whether it be Securities that were issued at a margin of autos or CMBS. Certainly the disciplines that somewhere over something like 10 basis underlie our market and the level of points or 15 or 20 basis points over the transparency I think are still very clear. The relevant benchmark in the respective markets do differentiate. You can compare jurisdictions some two years ago might now them to the US and you can actually see the be trading at $300, $400 or $500 over. You divergences. Take the auto sector that has get a security that trades at $300 one day, at been subject to a government initiative $600 the next. We’re very much a part of that recently—our markets are still fundamentally and are not going to be able to avoid that different from the US. If you take our market, part of the mess. But from a collateral we still have loans that have interest. performance perspective, I do expect us to be able to outperform global benchmarks. In the US you have ‘Sub-V’ loans whereby the manufacturers actually are subsidising Question from the audience the actual lending that’s being done for its (name withheld) own product. That’s to help ‘get metal on the I think a lot of your comments around the road’, as they say in the US. It’s one of the distinctions between the US market and the key structural problems with the US auto Australian markets are really tailored to the market as we sit here today. residential mortgage-backed security (RMBS) markets. In Australia, it’s like a consumer loan for a similar product, which the manufacturer uses Just interested in your views around how to get metal on the road. The differentiation our market and our market practices and here in Australia is that we will load the car protections stack up in relation to the broader up, but we will actually put extras into the asset classes that are available. vehicle to both enhance the proposition for the buyer and also try and enhance the ANDREW TWYFORD second-hand car market. Certainly from an offshore perspective, it’s really only been predominantly residential In terms of CMBS, it’s probably a little bit mortgage-backed securities that have been different. The commercial market is obviously issued into the marketplace. More recently, I one that’s under a fair deal of pressure, and think we have seen some auto securitisations there’s a government initiative going on cross over into the offshore markets. Clearly, behind the scenes there at the moment. we have had CMBS—or commercial Again, the disciplines are very good there. mortgage-backed security—transactions issued into the domestic marketplace. The key stuff that we have seen in the commercial market has really been large Certainly, from a depth of knowledge on how ticket items. The listed property trusts have those particular products work, because really captured that market early, so they had we’re not deliverers of those products, I’m their own disciplines with the way they were probably not in the best position to comment structured. The responsible entities were on that. Maybe Gary could comment on how very much set up for securitisation. Then they would shape up. 138 Australian Securities and Investments Commission | ASIC Summer School 2009

overlay that with the very low LVRs—typically really delve into the crux of it, it really comes at a AAA level, you’re talking sort of 30%– down to a demand and supply issue. 35%. So in that, they were very conservative Simplistically, to me that means confidence from that point of view. and liquidity.

Contrast that to offshore, you had more of I suppose on the liquidity side we have heard the high-volume style of commercial loans. that government intervention can fix that sort Or if you go head-to-head with the of thing, but on the confidence side to me the commercial, they had much higher LVRs as biggest crux is the pricing transparency well. They would certainly push the barrier issue. In Australia, it’s never really been a and I think some of those transactions that transparency issue. It’s been a relatively have come under fire are certainly going to easy process to get the information and to be have some challenges. And from a rating able to do credit assessments on credits, and point of view, some of the lower-rated trusts work with people like Andrew to get the have also been downgraded with those information to do your credit work. offshore trades, so I think the disciplines are there in terms of the other asset classes as As we have worked through this crisis and well. But we are certainly dominated by the delved into some of the aspects of the residential market and that’s where I think volatility around pricing, we start to see how transparency is a great thing. the infrastructure has been built around a fairly stable system. But then, as the markets But I’ve got a parochial saying: ‘Don’t attack got volatile and we saw counterparties fold, something with a sledge-hammer when a few like Lehmans—the banks starting to shed tweaks with a screwdriver might just do the staff—the cracks started to appear in that job’. What I simply mean by that is, we’re infrastructure. And last night they even spoke quite transparent now. We could do things a about what’s ‘broken’. To me that system of little better—but let’s not overwhelm the need pricing is broken here in Australia. for transparency or regulation with what’s actually going on there at the moment. Probably, purely because of a few unique factors that are really inherent in the MICHAEL DWYER Australian market, the most overriding one is We might now look at pricing valuation that the depth and the volume of the credit transparency. The McKinsey that’s traded in Australia is somewhat less recommendation was to expand and improve than say our counterparts in Europe and valuations by independent third party sources America. So some of the IOSCO proposals and to improve the structure and contribution for the price trace system may not work in process for specific types of securitisation Australia because securities just don’t trade and structured products. Australia basically that often, especially in the space where the has adopted a similar platform. Rob, do you pricing transparency is at its least. want to comment on that? When you look at the market as a whole, you ROBERT CAMILLERI ask, how is the pricing structured? You’ve got I suppose the conference has covered a lot probably three sectors of the credit markets of the problems and causes of the crisis and per se: starting with the lowest risk, which is some of the solutions. When you start to our government sector; then moving on to Structured products: how will we deal with them in the new financial markets? 139

corporates; then structured finance products, Their resources are stretched—in some which is RMBS, autos, CMBS etc. The first banks whole divisions have been retrenched. two have probably done fairly well and are You have seen companies like Citigroup who fairly transparent. said, ‘It’s just too hard to do anymore; we just won’t give the information’. There’s a market system called ‘Yieldbroker’ (which 11 banks are a part of) and you can Banks like ABN AMRO would say they will go to that system any day and have a look at only support their own deals, and various rate sheets, which are all provided by the banks have taken that approach as well. inputs of those 11 contributing banks. And to Some of the other better-resourced banks, me, that’s what I call a transparent market, there are probably only three left in that area, almost akin to an equity market or equity provide a more comprehensive rate sheet. exchange. It is very visible for all the over- You can get a good feel of where some of the-counter market to see where you can these marks are coming from. But even from value a corporate security. their perspective, their resources are stretched to some degree because what When you start to move into the structured they’re doing is taking a holistic approach to finance products, you can see that the segments of the market. They’re grouping market there is very fragmented in terms of together similar issuers or similar issues. its pricing transparency and the willingness to even provide a mark. The way the originate- Consider the new and used car market to-fund model works is that you typically where you have maybe half a dozen car need a non-bank or a sponsor bank (an ANZ, manufacturers (for which half a dozen non- a NAB or a Deutsche Bank) to bring these banks and banks are issuing products). issuers to the market and typically that bank Within those car manufacturers, you’ve got or that sponsor bank would put those different models and series—these are all the securities on their rate sheet. different deals that are issued into the market. And every year there are a series of Now, if that bank’s no longer there, or never cars that are made and these are the series actually had a division that provided that rate of loans that are issued into the market under sheet, it’s very hard to get a price for some of a series structure. But those cars in a new these securities in the secondary market and and used car market trade at different prices you work on relative value propositions. and we can see that relatively easily, because you can go to a used car market, If we go a step back, probably going back you can go to a showroom and you can see two years ago, there were probably some the price very visibly. It’s the fragmentation eight or nine different investment banks and that is dealt with through that particular banks that would provide marks on the market. market. Now, we’re probably down to three and that doesn’t cover the whole market; it In the securitisation market, we haven’t got a probably touches on about 30%–40% of the way to deal with that fragmentation. So structured finance products that are out effectively, we group all the cars made by there. Toyota into one bucket and say, ‘that’s the price’, and we can only see that this falls into You put that down to what they do in terms of that process. trying to provide the best marks available. 140 Australian Securities and Investments Commission | ASIC Summer School 2009

You know, the resourcing, and that process, makers will come and price that index and it’s is really probably the first fundamental a series of bills. We do that with swap rates problem that we can see in the market and for the banks. where some of the pricing problems exist. If I were to simplify it and say, what are the So we can develop an industry standard, actual problems, number 1 on my list would which is like a benchmark RMBS deal, and be that the resources of the market price we can do that over the three sectors that makers are limited. Then you have the Andrew spoke about. We can do the prime problem of getting the prices fed into a global space, the Alt-A or ‘low doc’ space, and even pricing company who would then feed that the non-conforming (or subprime) space back into banks’ balance sheets, or even the here. And do that over maturity time books of investment funds such as the ones frames—one year, two years, three years. I would manage. We can develop a benchmark pool, working When you look into the resourcing of these with the rating agencies looking at—for firms, it is even more stretched. In Australia, example, if it’s a prime pool, what’s a there are three guys out in Melbourne that benchmark LVR for a prime pool? Is it 60%, probably price around 98% of all fixed is it 70%? What’s the benchmark geographic income in this country. You’re looking at that distribution for a pool? Is it 20% in New resourcing, and then you’ve got to ask the South Wales, 20% in Victoria? What are the question, is that adequate? arrears levels?

There are questions around that model about We can form these points of reference, then where they’re getting their pricing from. we can deal with the fragmentation, because The sample size is relatively small, because it’s very easy for the whole market, including they’re really only relying on three banks, all the price makers and myself, to come that don’t cover the whole market. So that together every day and, say, put a bid offer firm then has to try to make a value on a very generic security, because we all assessment, and ask, ‘How do we price the know where the generic security trades. rest of this market? We can’t do that daily; It’s when you get into the finite granularity of we can only do it every three weeks, which an issue—a security issued by Andrew or a then has ramifications on capital for security issued by another originator—that insurance and banks that have these there are differences in those securities and securities marked in their books. it’s how do you price those? For me, as an That’s a resource issue and that’s on both investor, that relative pricing is very, very sides of the ledger. We have touched on the important. sample size and the infrastructure. How that At the moment, I’m trying to work on a deal whole mechanism works is what the market with Gary, where he showed me a credit, and needs to deal with. I have no issues with that. We have got So, what are the solutions? Well, the market through part of that process, and now we’re itself can actually provide benchmarking trying to determine an appropriate financing figures. We do that already for bills. There’s rate. However, I’ve just spoken to the pricing the bank bill index and every day the market provider and they just don’t know. So, as a lender to Gary’s client, if I lend this money, Structured products: how will we deal with them in the new financial markets? 141

then it gets put into this portfolio and it gets got traded over night in the US at $450 over marked at 98 cents in the dollar on day one. bills. So it’s just going one way and it’s all I’ve got to step up to my Board or my client fairly ugly. that I’ve been managing that money for and explain why I made that decision. You certainly don’t want to be mark-to- market at $450 when you’ve bought it at GREG MEDCRAFT $100. You’ve certainly made a principal loss, That might be a pretty good time to move albeit on a floating rate instrument. So you’ve over to Gary and ask him to respond on the got those sorts of tensions, if you like. bank’s perspective. Gary? GRED MEDCRAFT GARY SLY Do you want to comment on the overhang Rob makes some very important points. One problem in Australia? of the things we have here at the moment is a very dysfunctional market. We don’t have the GARY SLY depth of the government market even How big is it? We’re talking about the domestically and we certainly don’t have the overhang and I guess what we’re talking depth in other markets around the world in about there is in terms of the holders of these terms of the UK and the US, where there is a instruments: how many of those do we need lot more trading in the secondary market of to reprice, or get rid of? I guess the latter is these sorts of instruments. Traditionally, really what we’re seeing at the moment— certainly from our side, they’ve been viewed as those that may be trying to deliver their more of a ‘bottom drawer’ style of investment. books (because for some reason there might So they are putting certain components on have been a change in their investment fund manager books and they typically sit portfolio), remixes because of where equity’s there. That’s sort of the secondary side. We’re gone or where true fixing’s come or where not seeing much of that. cash has gone. So they actually have to unload some of this paper and that’s when There are a couple of components that are these people—it forces their hand to go in probably keeping up, probably with some the market and try and find a price. reluctance on our part—whether they be the banks from our own credit trading books or MICHAEL DWYER investors deciding not to go ahead and do Gary, better say that the volume or size of too many trades in the secondary market— those secondary market trades of the because they actually could go forward and materially dislocated $450 are much smaller. reprice their own books. So the spectre of So an investor might have purchased, you mark-to-market is across it all, particularly on know, $50 million or $100 million and the the bank’s side. It’s something we have to trades can be as little as sort of like a $1 face all the time. million original face price that are repricing the marketplace as well, which is causing So, you go out and do a trade. You might additional frustrations for the likes of Rob and have bought the note at $100, you might ourselves as issuers trying to say that our even go back to the halcyon days at $15 and securities are valued at a particular level in $20, and now they’re trading at $250—or, by the marketplace. way of market update, some Aussie RMBS 142 Australian Securities and Investments Commission | ASIC Summer School 2009

ROBERT CAMILLERI what we’re seeing offshore is that the It’s a very good point because what you’re Australian collateral is not really driven by really talking about there is the difference credit concerns or the fault risks on those between a seller on the day who for any particular assets or those particular specific reason just has to sell. You know, securities. Everything is getting tainted with we have been on the opposite side of those the same brush. So to us—and I think trades where we have looked at a seller’s everybody would agree, it’s an extraction of stock and the feedback we have got is they a huge liquidity premium because all the really need to sell this stock today. sellers of these securities are trying to sell the best collateral, because that’s where they There are almost no buyers in the market, can get the best price sometimes for liquidity. and coming up to Christmas Eve, we had desperate sellers knocking on our door, MICHAEL DWYER saying, ‘Can you please buy this stock?’ So It’s a liquidity issue, not a credit issue. Maybe you can sort of see the desperation of those we might move on to rating agencies. I guess sellers and the market timing of when these in terms of the McKinsey recommendations, things occurred. I’ve heard a lot about restoring market confidence in CRAs by enforcing Now, last night, we had some very bad news transparency in the CRA process. out on the market that would drive some sellers to the point where they would, either Obviously one of the Australian policy for liquidity reasons or portfolio movements— objectives is to achieve more transparent or even after the revaluations trying to methodology and comparability. Ben, do you rebalance their portfolio—have to sell want to comment? something. BEN MCCARTHY GARY SLY One of the interesting things you talk about is I think to put it in perspective, the overhang in world’s best practice and, to some extent in the market is actually part of a global Australia, we’re going to find that world’s best problem. And I particularly emphasise in practice for rating agencies is going to come Australia that, essentially, part of the problem largely through international regulation of of the market recovering is the clearance of rating agencies that are active here. this overhang. The three major rating agencies in the world ROBERT CAMILLERI are getting regulated by the SEC, the EU and That’s exactly right. I mean, yesterday we IOSCO, and the industry is largely following touched on—and I think everybody agreed— them and to a significant extent is also that the banks and the investment markets looking at the most onerous of any of those cannot address the overhang (we’re talking regulations and implementing those about the Australian overhang), but globally worldwide. and I think everyone in this room understands that there has to be some sort It makes it easier for Fitch or S&P (Standard of government intervention. & Poor’s) to run its business and do it that way with such a global market. So if we rate The biggest difference between what’s something in Germany, or we rate something overhanging in the Australian collateral and in Singapore, it could be an investor in Structured products: how will we deal with them in the new financial markets? 143

Australia who is using that rating. Therefore, covered by regulators. Rating agencies have we need to be able to comply with regulations universally agreed that such a split is all around the world at once. I guess this appropriate and as far as I am aware all morning people discussed some of those agencies now have this split between the issues and the issue of having global analytical side and business side. The bit regulation, which I think is something that all that’s not covered by regulators—and won’t the rating agencies certainly would appreciate. be able to be covered by regulators—is if they’re doing a good job on the credit. That’s There was an interesting analogy yesterday the part where rating agencies are really at one of the seminars, where Graham Ezzy looking internally to see what we can do to of Ernst & Young talked about the recent change the way we have done things and shark attacks in Sydney and how there’s improve that process, and improve the been three shark attacks in Sydney in the transparency, so that people feel that they last two weeks. He wanted to know when it know why we say something is AAA or AA, was safe to go back into the water. or what factors could come into that assessment to make it change from AA to a I thought that was actually a pretty good different rating. People want to have their analogy for what we’re seeing in structured eyes wide open and say, ‘Well, I understand markets now, in that you’ve had shark why you said it’s AA. I also understand what attacks, if you like, in the markets. But people the factors are that would change it from AA aren’t even getting in the bath at the moment to BBB or to AAA.’ because there’s water there. The idea for everybody in that market is to improve the Just to give you a sense of some of the transparency or the comparability of that things that have changed—rating agencies water, so you can see what’s actually there have become a lot more forward-looking than and know that you’re not going to pick up a they were before. As part of an effort to look rock at some later point, and see that there’s further into the future, we have introduced something under it you didn’t know about. ‘outlooks’ at Fitch, so we’re looking three years down the track at what the direction of So, from a rating agency point of view, this ratings will be over a longer-term period. We idea of building confidence comes from a had previously done this for corporate and number of places. The first thing, from a bank ratings but have now broadened this to rating agency point of view, when we sit include structured finance. down and look at what we do, is just fundamentally to get the credit right—and We have also introduced various other that’s the starting point. The second issue is measures for ratings to answer some of the transparency—how you got to the answer, in questions where people didn’t realise that our terms of what your view is on the credit. It is ratings were very specific on what they an opinion, so we have got to justify that covered. Fitch’s credit ratings relate to opinion to the world on how we got from A to default probability and they don’t address a B. And the third issue is governance. lot of the market risk or loss severity or loss- given default issues. What we found over the Now, the governance issues in relation to last year is people would like us to be able to splitting the business side from the analytical do that. They would like our ratings to side for ratings are largely going to be actually cover a larger spectrum of the risks 144 Australian Securities and Investments Commission | ASIC Summer School 2009

involved than they actually have in the past. the market. That’s the key part, actually So Fitch has looked at addressing some of getting practitioners in, getting life those issues. Recently we introduced loss commentary from the agencies coming in to severity ratings for structured finance talk and run through the processes that they securities. do every day. You’re getting the legal side, the accountants in. MICHAEL DWYER What I might do is move on to education. As ANDREW TWYFORD another aspect of improvement in the market, I think also there’s the courses for the McKinsey recommended that the industry industry, but also I think there probably should establish and enhance educational needs to be more education of regulators programs aimed at directors and executives and other parties, because I know in America with oversight of securitised products and that is something that we focus very heavily structured credit groups, as well as investors on. with significant exposures to those. ROBERT CAMILLERI GARY SLY Education is the crux of where you start as a In Australia, I think we’re a bit ahead of the professional, and some of the problems that game. The ASF, the Australian Securitisation we’re discussing today are about lack of Forum, has been up and running for 15 years expertise or lack of understanding. now and we’re part of that process. And one of the early things that we put in place was Ben spoke about rating agency challenges an education program, both for people who and there have been some very well are actually practising in that industry, but publicised parts of the Australian market that also for others from ancillary services or got involved with a certain sector that purely simply parties that have an interest to come relied on a rating because they just weren’t along. well informed or they weren’t educated. So the industry initiatives here are very, very There are two key streams of that. The first is important and as regulators what you guys effectively a basic course, a beginner’s have to understand is that you’ve got to say, course, where you’re given just the basic where do I want to expand that and make it fundamentals of securitisation, the quite actually policy? simple ones where you typically use those for funding—so looking at residential deals, auto If you go back through some of what ASIC’s deals, and those sorts of things. The course done since the turn of this century, they looks at each part of the process from what brought in the ASFL (Australian financial the client’s needs are through to the agency services licence) regime, which was fantastic process, the modelling then through to the because it protects consumers. They brought sale. Also we have the advanced course, in ‘know your client’ and that applies for my where we get a little more technical and drive business very well. What they took away a lot more into the detail and those sorts of were some of the wholesale protections in things. the market: for example, I used to have a dealer’s licence and where I had to sit a ‘fit One of the key components of the education and proper person’ test to actually go and program is the lecturers actually come from manage money. That regime is no longer Structured products: how will we deal with them in the new financial markets? 145

there because my licensee has to make that really struggling for liquidity because the determination which is fine. It’s a workable capital markets had shut down on them. model and the whole model measures you by the size of your wallet rather than your In terms of addressing that, one of the first expertise. ones that came out was the AOFM, the Australian Office of Financial Management. MICHAEL DWYER I guess the AOFM has the key to the Greg, did you want to just briefly touch on Commonwealth Treasury and they were government intervention and wrap up that given the mandate by the Rudd government end of it. to invest up to $8 billion in the RMBS market and at least $4 billion of that has to be GREG MEDCRAFT directed towards the non-banks. Just to mention about global coordination— basically what’s happening in the markets is To date, we have done four transactions on we now have a global group established to that and, in that case, the AOFM actually really look at what’s happening around the steps up and plays a part of what we call a world in terms of development and try to get ‘cornerstone’ investor. They don’t buy the uniformity of approach. It is also trying to whole transaction, but they will certainly buy identify where new products emerge and see typically the lion’s share. But there still has to if there are some issues that need to be be third party investors, whether they be at addressed early. It was almost like that the senior end, or the senior end in terms of comment earlier about some sort of risk scan those transactions. The AOFM has a one-line process to make sure that things are not mandate and that is to seek to improve going to blow up in the market. competition. Those first few deals went very well. It’s fair to say now that I think the MICHAEL DWYER longevity of the market is much better than Just moving forward to government what we thought it was going to be, so that intervention—maybe I might just pass over to $8 billion is going to be evaporated if I just Gary on that point. Do you want to just continue that same process. comment on what your view is on that? There is probably a need to really regroup GARY SLY and think, what other things can we now do Some of the initiatives that have been to help this crisis? I guess one of the things undertaken have been fabulous. I guess in they’re looking at is in terms of looking at this the early days—to address, if you like, the overhang we have been talking about and pointy end of liquidity—we had changes to ways of dealing with that, whether they be the repos in terms of what could actually be proactive—actually go out themselves, put sold in the repo window and with the themselves in the market and buy those inclusion of RMBS. That was then expanded securities—or be more reactive, where they to allow banks to set up programs for sort of basically sit there and say they’ll put a floor true back stops in terms of the liquidity, but under a price and have investors actually it’s fair to say those initiatives were purely come up and deal with their overhang in that directed at that market end of the liquidity way. That’s probably more of a domestic spectrum and didn’t really assist the likes of focus, probably more difficult from the the non-banks such as Challenger that were international side—always sounds good in 146 Australian Securities and Investments Commission | ASIC Summer School 2009

theory as well. But I think we’re probably at then taking the information, saying, ‘We have that next phase now where there’s been a a field of information here which is the few important initiatives and we have income: what due diligence do we need to do probably moved on in terms of RMBS. in respect of that field of information?’

MICHAEL DWYER For example, in the United States, verifying Thank you, Gary. Do we have the right income was a big issue in the subprime crisis people in charge of looking at what went because of ‘lie loans’. So now they want to see wrong? The people sitting up here have been that the IRS—the tax return—as opposed to the ones who have been involved in the the pay slip which you can get off the internet industry for the last three or four years. Do fraudulently. So I think there’s a lot of work to we have a proper segmentation of what went do, but I think it’s a good start. wrong and what we should do in the future, Question from the audience or is there a bigger job for the regulator in (name withheld) perhaps overseeing it to a greater extent? I’ve got a question for Greg and the panel. GREG MEDCRAFT Greg, you referred to some recommendations I think it’s a partnership. I think at the end of for sharpening up the representations and the day, the industry is concerned as much warranties in relation to securitised loan as anybody to make sure that it survives and portfolios. I’d be interested in the panel’s view prospers. McKinsey reached out across the on what that might mean, particularly for the world to the stakeholders and said, ‘What’s prudentially regulated issuers. Is that likely to the problem?’ and they’ve come up with this make it more likely that loans would be put basic platform. And I think as regulators, it’s back onto the balance sheet of prudentially just a matter of seeing whether that needs regulated entities? some enforcement, some backing to make GARY SLY sure that what’s been identified does happen, I guess that falls to the banks, doesn’t it? I and I think that’s where the partnership think in terms of the McKinsey comes in. recommendation, I believe it is still very much I think it’s quite interesting watching the a US-centric comment. It was actually reps processes in parallel with what the regulators and warranties and also repurchase are looking at. They have the same sort of agreements—and they’re really pointing that concerns, and I guess it’s a matter of that out, trying to fix up the adjustable rate partnership with industry to make sure that we mortgage in the subprime sector over there. actually do restore confidence for investors in In terms of our reps and warranties, I’d say the market. I think the approach that’s been it’s probably more remote. taken in terms of really going back to basics in That could mean that loans are going to be the United States is really going back and brought back on the books of the banks. We saying, what fields of information need to be have just been through a process with Basel disclosed to investors? II. Off the back of that, APRA (the Australian Rating agencies—if somebody doesn’t Prudential Regulation Authority) has actually disclose that information, you’ll refuse to rate revised the guidelines that relate to the deal. They’re the sort of things that are securitisation and funds. It’s called ‘APS very important market-driven solutions. And 120’, so it’s like our bible or the big stick Structured products: how will we deal with them in the new financial markets? 147

above our head. And if anything, the GARY SLY requirements around true sale and things I think what has happened in Australia—and I staying off balance sheet, in terms of the think through the crisis we have now seen assets themselves, from a regulatory point of securitisation work—so we have actually had view have actually become stronger. some entities, whether through a parent or otherwise, whereby we have had to invoke GREG MEDCRAFT the documentation, push those reps and I think, in fairness, in America it was so warranties around a little and replace certain fragmented, the whole representation on parties within those transactions, such as the warranties issue, whereas I think in Australia servicer who is doing the front end. it’s actually almost standardised because of the limited number of participants. When we Through that process, you finally get to dust did it years ago, APRA actually regulated that off those documents and actually test some pretty tightly. of those reps and warranties, and that’s certainly an interesting process. Certainly, ROBERT CAMILLERI from the investor side we have been getting There are a number of checks and balances feedback about cases where investors have inherent in the system. taken positions in certain transactions and have almost been prevented from getting BEN MCCARTHY through to talk to the key people around Just on the reps and warranties, one of the those transactions, really even to get simple things that has been found in the US is that updates. Quite often that falls on the trustee. the reps and warranties can be standardised, There may be some work we need to do but you need to know who’s actually giving around those in terms of enhancing those— them and whether they’re credit worthy and again, it comes down to transparency. whether they can actually stand behind them.

In the US, certainly, they’re finding that in MICHAEL DWYER some cases the entities that gave the reps Okay. Will you please join with me in and warranties don’t exist any more and then thanking Greg and the rest of the members what do you do? of the panel for an informative session?

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TUESDAY The future: a new financial order? ASIC priorities: a panel discussion with ASIC’s Commissioners

Panel discussion Moderator Mr Peter Thompson, ABC television and radio broadcaster Mr Tony D’Aloisio, Chairman, ASIC Mr Jeremy Cooper, Deputy Chairman, ASIC Dr Peter Boxall AO, Commissioner, ASIC Mr Michael Dwyer, Commissioner, ASIC Ms Belinda Gibson, Commissioner, ASIC Mr Greg Medcraft, Commissioner, ASIC

TONY D’ALOISIO controversial actions, like the ban on short At the last Summer School, we said our three selling, but the crisis must change your priorities were: priorities to some extent?

capital markets—specifically, insider TONY D’ALOISIO trading and market manipulation As I said, our priorities haven’t changed as disclosure such. What’s changed is clearly the urgency retail investors—in particular, how to and the type of issues that come up. For better protect and educate retail example, rumourtrage issues fit within the investors, and issue of capital markets, insider trading, market manipulation. But rumourtrage is a facilitating capital flows—which has now set of issues that came out of short selling moved to understanding what’s and potential false rumours. happening in the global financial crisis and its impact here. As for the issue of retail investors and better Global crisis issues fit within these three educating them, probably a year or so ago priorities, so essentially these remain our we were looking much more at issues that priorities and will be so for the next few could arise. But in more recent times, with years. Opes Prime, Storm Financial, we have seen issues that have actually arisen. So I think At our workshops, you would have met all or what the crisis is changing is not the most of our senior leaders. Our leaders have priorities, but the transactions or the urgency been appointed to take responsibility in areas of those matters that have emerged out of that fit in under each of those priorities. the current state of the markets.

PETER THOMPSON PETER THOMPSON How has the crisis actually changed what Let’s begin with reflections on the Summer you’re thinking about? There have been School overall. Greg, do you want to start? some actions clearly, some highly ASIC priorities: a panel discussion with ASIC’s Commissioners 153

GREG MEDCRAFT much the UK process with some adaptations Sure. In my view, the agenda was very well to allow directors to appoint early, to structured in terms of what went wrong, encourage them to take advice early to exploring the issues, what we have learned. ensure that they didn’t detrimentally affect I think it was perfectly framed for the times. creditors by continuing to trade whilst I think what it did is—by having the insolvent. stakeholders here and also the overseas input, endorse ASIC’s agenda—in terms of I think our regime will stand the test of time. the issues that we want to focus on, our I think the debate on Chapter 11 (US priorities. I think it’s actually been very useful bankruptcy procedure) versus voluntary in terms of getting that feedback, so I found it administration (VA) in Australia has been put very good. to bed a number of times. The professions— including the accountants and the lawyers— PETER THOMPSON and also the regulators are very much of the Michael? view that our VA process, together with our insolvent trading laws that require directors to MICHAEL DWYER take advice early, is far and away a lot better Thanks, Peter. I heard last night that, after than leaving the directors in charge of the 16 or 17 years of continuous growth, in 2007 restructuring process for Chapter 11. insolvency dropped off ASIC’s priority list. I’m sure it’s firmly back there now because of the PETER THOMPSON global financial crisis and I think the feeling Greg, just back to you briefly. Last night that I’ve got from today and one of the things David Murray—one of his more interesting I take away is the great cooperation comments—related to the thanks given to internationally. Globalisation has obviously HIH for giving us a headstart on how to led to that. It’s led to some problems, but restructure the financial system. When it I think the international community of comes to securitisation, are you comfortable regulators and the degree of cooperation that with what our regulatory framework is? is there is something that has very pleasantly surprised me. GREG MEDCRAFT As I said before, in Australia the issue is not PETER THOMPSON a credit problem, it’s a liquidity problem. The You hint there’s likely be more work. Is the Australian market is, fortunately, quite robust. state of regulation on insolvency adequate? But we are part of a global market and, as transparency and disclosure evolves globally, MICHAEL DWYER the Australian market is going to have to Yes, I believe it is. But, of course, I’ve come evolve with it. I think it’s fine, but it’s going to from that area and probably over the last have to evolve, because investors around the 15 years have been partially responsible for world are demanding more transparency. getting it to where it is. I think the basis for a sound financial system is a very solid One of the issues we do have to resolve is insolvency law and practice regime. the liquidity issue in this market. I’m not sure whether that’s a regulatory problem. It’s Fourteen years or so ago, we implemented something the market is going to have to what’s now commonly called the ‘voluntary resolve. As I said before, however, I think it’s administration’ regime, which mirrored very 154 Australian Securities and Investments Commission | ASIC Summer School 2009

a partnership between regulators and market products like CDOs to determine investor participants. suitability. I think that’s one of the lessons from this for both retail and wholesale PETER THOMPSON investors. Jeremy, let’s take it up from the financial markets perspective then— Put simply, a lot of the people who bought CDOs probably shouldn’t have bought them, JEREMY COOPER because they didn’t know what they were Over the last couple of days, we have buying. I think that is an issue that’s going to congratulated ourselves, and rightly, on a have to be looked at both in Australia and number of positive aspects of our system— globally. the banks are in good shape, our superannuation system still works. From a PETER THOMPSON behaviour and regulatory point of view, we Belinda, from the point of view of capital score well on a number of grounds, but the markets and listed companies, what are your reality is there are two things that really reflections on the last couple of days? matter in financial markets: greed and fear. We have caught a virus from overseas and BELINDA GIBSON the real issue is, notwithstanding that our I have a couple of takeouts, Peter. First, from markets are open and ready for business, yesterday morning’s session—we’re part of there is just a fundamental lack of an international world and we have got to confidence. work with the other regulators internationally to come to a solution for some of the issues We heard a very interesting session this that have come up. They do come down to morning on securitisation, quite obviously our confidence in the market; they do come to market was well-designed and well-thought capacity for Australia to attract capital. through, and the structures and the way it worked were all fine. It’s just that it’s not Secondly, a takeout from last night’s dinner functioning, and that’s all about confidence. and the discussion there—risk is all- How we bring that back is really the big important. It’s very important for directors, be challenge. they directors of listed companies, be they directors of financial institutions, be they PETER THOMPSON even directors of not-for-profits, to Greg, you want to chip in there — understand risk profile, understand risk assessment and work out how to manage GREG MEDCRAFT that. That seems to be a common failing. Yes, just one thing, when I talk about securitisation, I often exclude the CDO The third takeout from talking to people over (collaterialised debt obligation ) market. It’s a the last two days: the abiding interest and bit like the lost child in securitisation; nobody desire for a market with integrity, which is wants to actually own it. really a culmination of disclosure, prosecuting insider trading, and rumourtrage. But I think the CDO market is one area that They seem to be recurring themes of probably does need some better supervision. discussion over the last two days. From looking at it globally, I think there needs to be a stronger obligation on the sellers of ASIC priorities: a panel discussion with ASIC’s Commissioners 155

PETER THOMPSON role for regulators like ASIC in terms of the Peter, from your interesting perspective of rule of law, monitoring of systemic risk and having run federal departments and dealing providing the framework within which the with the impact and unintended markets operate. consequences of regulation, what’s your perspective as you look at these I think also what came through was: be proceedings? careful about the unintended consequences. In particular, be careful that some of the PETER BOXALL decisions taken now, which are taken in the Well, obviously as a person new to the area, understandable circumstances of the global it’s been a great learning experience for me. financial crisis, don’t lead to problems further On that question, I thought it came through down the track—don’t have unintended fairly clearly that there are certain things that consequences down the track. So there’s a caused the global financial crisis that are very big responsibility on ASIC and completely outside ASIC’s bailiwick, such as government as a whole to get the responses the global imbalances, the conduct of to the global financial crisis right, so that we monetary policy and things like that. But what don’t impede the recovery when it starts to really came through for me is the important emerge.

Questions from the audience (names withheld)

Question 1 wholesale level or at the retail level, that they We have been told over the last couple of do want some regulatory changes. It’s part of days that we have a pretty sound regulatory instilling that confidence, whether that be in system, also that Australia has been fairly the area of credit rating agencies, whether well-placed so far in this global financial that be in the area of disclosure on short crisis. Should we be worried about potential selling and other issues that we have over-regulation, and what actions should we, discussed over the last couple of days. the industry, be taking to work with you, the regulator, to ensure that we don’t become I feel reasonably confident at the domestic overregulated? level, however, that we will get the balance right. Perhaps we may not get the balance TONY D’ALOISIO right on every regulatory issue but, as a I think what you’re seeing this time around whole overall, I think we will. at the domestic level are regulators that are quite intent—and I’m speaking here not only When we move into the international scene, for us but I think for APRA and so on—on not it’s less predictable. We discussed this over-regulating and thereby impeding the morning the issue of how things would be very confidence we’re trying to create to reformed in the United States, the position reopen these markets. that Europe would take vis-a-vis the United States and the European Union itself in At the same time, because of the way events relation to some of these issues. have unfolded, there’s quite an expectation from investors, whether they be at the I think, at this stage, it’s just a little bit too early to call. We’re not down to enough of the 156 Australian Securities and Investments Commission | ASIC Summer School 2009

issues to be able to make the call about There’s quite a push on, from Europe in whether or not we’re going to end up with particular, to shift OTC transactions onto regimes more globally that are tougher than exchange traded markets on the basis that we may want—with the implication being it they would be more transparent, but I wonder would be very hard for Australia not to to what extent or how the Commission sees actually adopt those frameworks, simply the relative roles of OTC markets, which are because of the way that the markets are regulated in Australia like some other interconnected. markets, and the exchange traded markets here and the complementarity of those So, as I say, I feel reasonably confident at functions? the domestic level but I think it’s a ‘wait and see’ situation in terms of the broader global TONY D’ALOISIO picture. I might kick off. I think the OTC markets have played an exceptionally important role in our I don’t know if my fellow Commissioners want markets over many, many years and no to comment on it? doubt will continue to. I think the key issue, at least from my end, is around the counterparty MICHAEL DWYER risk. And basically, the feeling seems to be Also, in response to the last question, I think that if you push it more to exchange traded, it is the role of stakeholders (as we liaise with you’re likely to also back that with systems them) to point out issues where they think for managing counterparty risk. there might be unintended consequences. That’s one way that we can keep in touch I think at our end—at the ASIC end—it’s and hopefully minimise the likelihood there going to be a debate we’re going to see will be unintended consequences. unfold over the next couple of years. We’re certainly going to see it unfold at the IOSCO JEREMY COOPER level as we look at, for example, credit Just musing on Tony’s comments—he’s default swaps and what we see there. So I absolutely right that, if there are tectonic don’t have a general answer to your regulatory changes globally, we will have to question, other than that there are going to think very seriously about opting out of those. be significant moves to go exchange traded Just look how the ASX is trading at the and to manage the counterparty risk better moment. It seems to be glued to Wall Street than we have seen. How far that extends into and we all thought there was going to be a the OTC market and what products are left divergence, but if you look at it in US dollar and so on I have no idea at the moment. terms, since the end of 2007, our market has fallen nearly 65% in US dollar terms, so we BELINDA GIBSON were very much connected with those I might add to that if I may. I think the markets. element of transparency of most concern is counterparty risk. And at its plainest, when Question 2 Lehmans went there was this grave concern I’d just be interested in the Commission’s about just what would happen on Monday views on the function and the relationship when it was gone—all sorts of things were between the OTC markets and the exchange triggered and a lot of time had to be spent traded markets. ASIC priorities: a panel discussion with ASIC’s Commissioners 157

trying to work through that. That’s TONY D’ALOISIO counterparty risk. I’ll try and cover it as quickly as I can. We have approached stakeholder engagement at The other risk is an integrity risk—it’s the a number of levels, including this Summer market manipulation. OTC markets are still School and how we are organised internally. certainly available for insider trading, and We have stakeholder engagement through

CFD (contracts for difference ) providers are the industry associations and consumer very quick to tell us when they think that groups. someone’s insider-traded on their markets because they’ve lost—but they are available Each Senior Executive Leader (SEL) has a for manipulation. responsibility in relation to one or more of those associations and groupings. We also have in They are available, if you like, for profiting the consumer area a Consumer Advisory through rumourtrage and the like and, on any Panel. Below the SEL level, we encourage view, ASIC needs to have better visibility ongoing dialogue and discussion with our than we have had in the past as to what is stakeholders. At the Commission level, the happening on those markets, particularly as engagement with stakeholders is varied. It can they assume greater importance. be at Board, CEO level, or other levels within organisations. I think in Australia we have really focused in terms of manipulative activity on the share We have also institutionalised an External market. In the US, focus has also been on Advisory Panel to be available to advise the perhaps some manipulation of pricing in the Commission on key issues, whether they are CDS market—that’s credit default swaps. business, regulatory, or consumer issues. They are less of an issue here, as far as we We have done that as part of keeping us can see. But we need to prepare for an closer to the market and what is going on. expansion of our markets in time hopefully, We have appointed Dr John Stuckey as the and you need to be assured about proper Chairman of that advisory panel. We have oversight from ASIC in that, and that requires appointed, I think, 15 panel members. The a bit more of an exchange than perhaps panel members and the panel will meet exists at present. probably formally a couple of times a year, but will be available to the Commission at PETER THOMPSON other times to take advice on issues. We will Is there another question? be making a public announcement on the 7 Question 3 External Advisory Panel shortly. Just following up on an earlier comment Our commitment is to be more closely about stakeholder engagement connected with the market and with what’s opportunities—I was wondering if you could going on, so that we can act more quickly just update us on the new ASIC structure and and take more preventative steps. the establishment of the External Advisory Panel and possible stakeholder opportunities with the new ASIC?

7 See http://www.asic.gov.au/asic/asic.nsf/byheadline/Extern al+Advisory+Panel?openDocument 158 Australian Securities and Investments Commission | ASIC Summer School 2009

We have also instituted, and are instituting, that is a personal tragedy and the an international stakeholder engagement Commission is obviously sympathetic. You through our work on IOSCO and where we may have heard last week at Senate sit in the IOSCO Technical Committee and Estimates in relation to Storm (Financial the Executive Committee and the various Limited), there’s a very active and detailed task forces. We have a program of keeping investigation underway there, and also we’re close and connected and networked in with looking at all sorts of regulatory and possibly the major regulators for our markets—most compensation steps as well. notably, of course, the US, Hong Kong, Japan, UK and Europe and a number of the When you look at margin lending, for Asian jurisdictions and New Zealand. So I example—which was at the centre of the hope that gives you a feel for the seriousness problems with Storm—there was at the peak of this for us and the active steps we are of the boom nearly $40 billion worth of taking to have that dialogue with you. margin lending going on in Australia. Looked at systemically—in other words, not focusing Question 4 so much on the personal crisis on the ground We have been hearing over the last couple of level—but looked at systemically, the fact days that the regulatory settings are fine and that one financial planning group ran into Australia’s done pretty well out of this. But I extreme difficulties with margin lending might guess from where we sit: large numbers of actually be a pretty good sort of report card people have their retirement plans in tatters; on the system (particularly when, as we well people are losing their homes because of know, margin lending wasn’t even fully predatory lending and equity stripping regulated). That’s another platform that the practices; people are losing their homes and Government is rolling out. retirement incomes—retirement savings— because of mis-selling in the financial We are focused, we are sympathetic, but planning sector. So I just like to get a sense quite clearly in the areas of credit and margin of the degree to which the Commissioners lending, we really haven’t been there themselves are engaged with these very real because the regulatory tools haven’t been issues for retail clients. available.

JEREMY COOPER Question 5 Obviously, part of the answer to that is You talked about the domestic approach to political in the sense that the regulation of regulation. I just wonder with a lot of pressure credit is something that’s very much coming points around the world what’s going to be onto our patch and so we will be able to do a the role of IOSCO going forward? What’s lot more in that area once we have got a going to be the role of mutual recognition or responsible lending mandate to administer other cross-border arrangements going and so on. forward?

The second limb of your question related to TONY D’ALOISIO financial advice and people losing their I think the ability to have securities regulators homes. Clearly, any time someone loses a from 94 countries in one forum, together with home connected with an investment, whether a very strong Technical Committee that has they understood the risks involved or not, all the major capital markets on it, provides a ASIC priorities: a panel discussion with ASIC’s Commissioners 159

tremendous opportunity to deal with the sorts in the current economy and their fears for of issues we talked about this morning. So I insolvent trading prosecution. think IOSCO does have a clear role to play as indeed does the Financial Stability Forum This law is evolving, but there is a need not to and so on. stifle ‘entrepreneurism’ and also to ensure that we have a mechanism that protects creditors. The question is: will there be any tension And I think the law as it is designed is to firstly between the regulators coming together at ensure directors are aware of their bodies such as at IOSCO in determining responsibilities to creditors. Their duties under these issues and the policy setting for the the law are clearly to not trade whilst insolvent, governments of those jurisdictions? In our and I think we will be looking through our case, we work, for example, in IOSCO, but liquidator surveillance and referral system to we also work very closely with Treasury, so make sure that those duties of directors are that the whole-of-policy settings of enforced. government are feeding through so we can make submissions and so on that represent JEREMY COOPER the view that Australia may want to take. I’ll have a go at the Sons of Gwalia question. It’s a much misunderstood case. It only PETER THOMPSON applies where there’s money left over for the Time for a couple more —yes, the gentleman unsecured creditors. You mentioned HIH: in there. that case, there wasn’t any money left over, so it wouldn’t have been relevant. And Question 5 secondly, the ruling might be of comfort for Could you give some more input about this directors, because shareholder claimants intellectual capital regarding corporate might have more of a pool ranking equally governance? There are implications for with the unsecured creditors to claim against Boards and directors, especially in view of and might not actually be looking to be the decisions around the HIH (Limited) chasing the directors. collapse and the court rulings and secondly, the recent decision in the Sons of Gwalia If it were the other way around, then a case8 that creditors will have precedence shareholder who has been misled or lied to over the shareholders. So directors are more might be much more inclined to have a crack concerned in taking certain decisions that at the directors personally. So, oddly enough, might be of great help for the company, but Sons of Gwalia might actually be something they will withdraw for those kinds of steps. Is that directors should look upon perhaps more there any view in your area that these kinds favourably than they think. of concerns of directors will be addressed in the future? PETER THOMPSON I would like to thank all the Commissioners. PETER BOXALL I know people have been really hungry for I’m happy to have a go at that. In regard to the knowledge and information that came out the first part of your question, I think what of these two days. It’s been great to be part we’re talking about is—what you’ve asked of it. After two days of dense communication, about is—directors’ duties and directors’ role people are still with it. So it’s a great testament to the way the last two days have 8 Sons of Gwalia Ltd v Margaretic [2007] HCA 1 160 Australian Securities and Investments Commission | ASIC Summer School 2009

gone, but also to people’s interest and Again, that’s very important for us as enthusiasm to absorb more, understand ASIC falls within the Minister’s portfolio more, come to grips with these troubling responsibilities. It’s also important in that issues. It’s been very enjoyable to be part of I think it gave you an opportunity to see the it and, Tony, I’ll leave it to you make the issues that he is dealing with. closing comments. Probably the most important point that I’ve TONY D’ALOISIO made over the two days is that events like I’ll be brief, but once again I thank you all for this just don’t happen. They require attending. The objectives we set were to considerable planning and we have been identify the big issues, update you where we very fortunate that over the years we have were, give you a bit of a road map of what’s had a very strong culture of the ASIC ahead on the reform agenda and also Summer Schools being successful. The provide a venue by which we got to know you sponsors of the Summer Schools devote a better and you got to know each other, renew lot of time and attention with their teams to acquaintances and relationships and so on. get it to work. So, we’re very really pleased that we have achieved all those objectives and it’s really This year’s Summer School sponsor was been due largely to your participation. Joanna Bird who you have got to know. A very extensive team has ably assisted her. As Peter has just said, the fact that you’ve So, on behalf of the Commissioners here, we remained focused on the issues and stayed thank Jo and her team. It’s been a very with it right through is very pleasing for us, so successful two days and I think, Jo, that you we thank you for that. We thank our speakers and the team should really take pride in that. and panellists who gave up their time and provided high quality presentations. All their With that I will close the conference. We wish efforts were fundamental in a successful you well on your journeys and hopefully we conference. will see you next year. Thank you.

The Minister’s participation was also very CONFERENCE END important. He was genuinely interested in the subject matter and the views being expressed and that certainly came through in his keynote address. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 3

Profiles ASIC Commission Speakers Panellists Moderator ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 162

162 Australian Securities and Investments Commission l ASIC Summer School 2009

Mr Tony D’Aloisio was appointed Chairman of ASIC on 13 May 2007, following his appointment as Commissioner in November 2006. Tony was Managing Director and Chief Executive Officer at the Australian Stock Exchange from 2004 until October 2006. He was Chief Executive Partner at Mallesons Stephen Jaques between 1992 and 2004. Joining Mallesons in 1977, Tony practised as a commercial lawyer until becoming Chief Executive Partner. His practice areas were mergers and acquisitions, taxation and restrictive trade practices and international trade and investment. Tony was Managing Partner of the Year in 2001 and 2002 (Australian Law Awards) and received the Australian Government Centenary Medal in 2000 for services to law and taxation. Directorships and positions Mr Tony D’Aloisio Director: Boral Ltd 2003–2004; Business Council of Australia 2003–2006; Chairman, ASIC World Federation of Stock Exchanges 2002–2004; Australian Charities Fund 2001–Current Member: Business Council of Australia 1994–2006; International Legal Services Advisory Council 1998–2004; Board of Taxation 2002–2004; IOSCO Technical Committee and IOSCO Executive Committee 2007–Current

Mr Jeremy Cooper has been the Melbourne-based Deputy Chairman of ASIC since 2004. He was formerly a partner of Australian law firm, Blake Dawson Waldron, where he practised principally in mergers and acquisitions and corporate advice. Jeremy has oversight responsibility across a range of ASIC’s teams in the financial services sector. Jeremy is also a member of the:

l Corporations Committee of the Business Law Section of the Law Council of Australia

l Federal Government’s Corporations and Markets Advisory Committee (CAMAC)

Mr Jeremy Cooper l Industry Advisory Committee of the Melbourne Centre for Financial Deputy Chairman, ASIC Studies, and

l Policy Advisory Council of the Financial Services Institute of Australasia (Finsia). ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 163

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Dr Peter Boxall AO joined ASIC as a Commissioner on 2 February 2009. Peter was previously Secretary of the Department of Resources, Energy and Tourism, following six years as Secretary of the Department of Employment and Workplace Relations and five years as Secretary of the Department of Finance and Administration. He is an economist, with a doctorate from the University of Chicago. Peter commenced his career with the Reserve Bank of Australia, then spent seven years at the International Monetary Fund in the USA, followed by graduate studies at the University of Chicago and a graduate fellowship at The Brookings Institution. On returning to Australia in 1986, Peter joined the Treasury. He was Senior Economic Adviser to the Leader and Deputy Leader of the Opposition in Dr Peter Boxall AO the late 1980s and early 1990s. He was Secretary of the Department of Commissioner, ASIC Treasury and Finance in South Australia, then Principal Adviser to the Treasurer, the Hon Peter Costello MP. In 2007 Peter was made an Officer of the Order of Australia (AO) for service to economic and financial policy development and reform in the areas of accrual budgeting, taxation, and workplace relations.

Mr Michael Dwyer joined ASIC as a Commissioner on 16 February 2009. Michael is a chartered accountant and practiced in insolvency and restructuring for 30 years. He commenced his career with Touche Ross in 1976. He was a Partner of KPMG and its antecedent firm Touche Ross from 1986 to 2004, a Partner of Horwath (now BDO) from 2004 to 2006, and practiced as Dwyer Corporate from 2006 until he joined ASIC. From 1999 Michael spent five years in Adelaide as Partner in Charge of the KPMG Corporate Recovery practice. In 1998 Michael travelled to Indonesia to establish KPMG’s restructuring practice. During that 18-month period he acted as Senior Advisor on four successful major Indonesian corporate investigation and restructuring assignments, where debt owed, mainly to international banks, ranged from US$150 million to US$900 million. Michael was National President of the Insolvency Practitioners Association Mr Michael Dwyer Commissioner, ASIC (IPA) in 2001 and 2002, and was made a life member of the IPA in 2007. At ASIC Michael is responsible for regulation of insolvency practitioners, accountants and auditors, through both market oversight and enforcement. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 164

164 Australian Securities and Investments Commission l ASIC Summer School 2009

Ms Belinda Gibson joined ASIC as a Commissioner in November 2007. Her initial major role was to head the Capital Markets Taskforce, which undertook a review of ASIC’s position in enforcement of the capital markets offences, and identified measures to improve ASIC’s performance in that area. She has responsibility within ASIC for regulation of Australia’s capital markets, both in terms of market oversight and enforcement of the integrity and transparency laws. She also oversees the regulation of listed companies. Belinda was a Senior Partner of Mallesons Stephen Jaques’ Mergers and Acquisitions Group in Sydney before joining ASIC, and was a founder of that firm’s Corporate Governance team. Ms Belinda Gibson Commissioner, ASIC

Mr Greg Medcraft was appointed as a Commissioner of ASIC in December 2008. Prior to joining ASIC, Greg was Chief Executive Officer and Executive Director at the Australian Securitisation Forum (ASF) where Greg and the ASF played a key role in establishing a policy framework for reinvigorating the Australian securitisation market. As an Australian, Greg has a long history of working across global securitisation markets. Greg was Managing Director and Global Head of Securitisation at Société Générale Corporate and Investment Banking. Greg is the co-founder of the American Securitisation Forum and was its Chairman from 2005 until his recent return to Australia. In January 2008, Greg was appointed Chairman Emeritus of the American Forum and remains a member of that Board and management committee. Mr Greg Medcraft Commissioner, ASIC The American Forum is an industry group representing some 350 member (previously, Executive Director institutions comprising all major stakeholders in the US$1 trillion US and Chief Executive Officer, Australian Securitisation securitisation market. The American Forum has played a key role during Forum, Global Head, the current credit crisis having worked with US Treasury Secretary Henry Securitisation at the Société Paulson on a rescue package for troubled homeowners in the USA. Générale) ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 165

Emma Alberici Zarinah Anwar Ric Battellino Adrian Blundell-Wignall Robert Camilleri Kathleen L. Casey Chum Darvall Robert Elstone David Gruen David Hartley David Hoare Belinda Hutchinson AM Kim Ivey John Laker AO Catherine Livingstone AO Ben McCarthy Ian Macfarlane AC David Murray AO Stephen Roberts Graeme Samuel AO Hector Sants Senator the Hon Nick Sherry Gary Simon Gary Sly Michael Smith OBE John Stuckey Greg Tanzer Peter Thompson Andrew Twyford Martin Wheatley ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 166

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Ms Emma Alberici is the ABC’s Europe Correspondent and has been based in London since August, 2008. Prior to moving to London, Emma was a senior business journalist for ABC TV and Radio Current Affairs. She worked on The 7.30 Report and Lateline Business, as well as reporting for AM, The World Today and PM. Emma joined the ABC in 2002, where she presented a new business program, called Business Breakfast. The program was on air from June 2002 until August 2003. Emma went on to co-host Midday News and Business. Emma has twice been a finalist at the Walkley Awards for journalism. Both times were for investigative reports, first on the death of a patron at Star City Casino in 1998 and then in 2001 for uncovering the Tax Office’s treatment of taxpayers who participated in mass marketed schemes. Emma spent close to ten years at Channel Nine where her career spanned Ms Emma Alberici reporting for Money, Business Sunday and A Current Affair, to presenting ABC Europe Correspondent the finance report on the Today program as well as helping launch The Small Business Show. She is the author of The Small Business Book, published by Penguin.

Ms Zarinah Anwar is the Chairman of the Securities Commission (SC), Malaysia, a post she assumed on 1 April 2006. She had served as Deputy Chief Executive of the SC and member of the SC since 1 December 2001. Zarinah is Vice Chairman of the Emerging Markets Committee of the Ms Zarinah Anwar International Organization of Securities Commissions (IOSCO). She was Chairman, Securities Chairman of the ASEAN Capital Markets Forum, a grouping of chairmen of Commission, Malaysia ASEAN securities regulators, from 2006 to 2008. Zarinah currently chairs the Malaysian Venture Capital Development Council and the Capital Market Development Fund, and is a member of the National Economic Consultative Council (NECC), the Labuan Offshore Financial Services Authority (LOFSA), the Foreign Investment Committee (FIC), and the Board of Directors of the Institut Integriti Malaysia (IIM). Zarinah started her career in the Government Legal and Judicial service where she served in the courts as well as the Attorney-General’s Chambers. Zarinah subsequently spent 22 years with Shell and was Deputy Chairman of Shell Malaysia prior to joining the SC. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 167

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Mr Ric Battellino is the Deputy Governor of the Reserve Bank of Australia and a member of the Reserve Bank Board. Prior to this he held senior positions in the Financial Markets and Economics areas of the Bank. He has had over 30 years’ experience in central banking. Mr Ric Battellino Deputy Governor, Reserve Bank of Australia

Dr Adrian Blundell-Wignall is the Deputy Director for Financial and Enterprise Affairs (DAF) at the Organisation for Economic Co-operation and Development (OECD). He is also Chairman and portfolio manager for The Anika Foundation. Adrian has held the following senior positions: 2002 Citigroup (Australia) Ltd; Director, Head of Equity Strategy Research; 2000 Executive Vice President, Head of Asset Allocation, BT Funds Management; 1993 Head of Derivative Overlays and Levered Products at Bankers Trust Funds Management, building a new $4 billion business; 1991 Head of the Research Department at the Reserve Bank of Australia, directing a department and participating in monetary policy discussions at the internal pre-Board meetings. In his early career, he held economist positions in the OECD Economics Dr Adrian Blundell- Department, the Reserve Bank of Australia and the Economic Planning Wignall Advisory Council of Australia. Deputy Director, Financial and Enterprise Affairs, Organisation He graduated with First Class Honours and a PhD in Economics from for Economic Co-operation and Cambridge University, UK. Development Adrian has published extensively on financial markets and monetary policy, as well as broker analyst studies and reports. Adrian’s most important achievement is founding and acting as Chairman of The Anika Foundation, a rapidly growing and high profile charity which provides education research scholarships in the area of adolescent mental health, depression awareness and suicide. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 168

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Mr Robert Camilleri is Senior Manager, Credit at Aviva Investors and has over 14 years of industry experience. Rob started in the industry at ANZ Treasury as a Quantitative Methods Analyst, before moving into funds management. At present, he is a key contributor and specialist analyst in Asset-Backed Securities for Aviva Investors. He is also Portfolio Manager for the short duration funds, international fixed income portfolios and Deputy Portfolio Manager of the High Yield Fund. Rob is a member of the Executive Committee of the Australian Securitisation Forum (ASF), and also lectures on securitisation as part of the education arm of the ASF. Mr Robert Camilleri Rob is a major contributor to the financial services industry and has Senior Manager, Credit, Aviva participated in the Global Steering committee for Project Restart. He is Investors Australia Ltd Chairman of the Transparency Task Force and the Melbourne Bondholder Roundtable locally. He holds a Bachelor of Business (Economics and Finance), a Diploma of Financial Services (Financial Planning), an Associate Diploma of International Trade, and is a member of the Association of Taxation and Management Accountants, and Industry of Society Leaders.

Commissioner Kathleen L. Casey was appointed by President George W. Bush to the US Securities and Exchange Commission and sworn in on July 17, 2006. Her term expires in 2011. Prior to being appointed Commissioner, Ms Casey spent 13 years on Capitol Hill. Before her appointment as Commissioner, she served as Staff Ms Kathleen L. Casey Director and Counsel of the US Senate Banking, Housing, and Urban Commissioner, US Securities Affairs Committee. and Exchange Commission Ms Casey was primarily responsible for guiding the Chairman’s and Committee’s consideration of, and action on, issues affecting economic and monetary policy, international trade and finance, banking, securities and insurance regulation, transit and housing policy, money laundering and terror finance. Significant issues the Committee considered under Ms Casey’s direction include: reform of Government Sponsored Enterprises, reauthorization of the Terrorism Risk Insurance Act, Deposit Insurance Reform, Insurance Regulation, Foreign Investment in the United States, Sarbanes-Oxley implementation, and Credit Rating Agencies. A member of the State of Virginia and District of Columbia bars, Ms Casey received her JD from George Mason University School of Law in 1993. She received her BA in International Politics from Pennsylvania State University in 1988. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 169

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Mr Chum Darvall was appointed Chief Executive Officer Deutsche Bank Australia and New Zealand in July 2002. He joined the bank in September 1994 as Director Treasury managing the money market, swaps and foreign exchange units and group funding. In early 1998, he became Head of Global Markets responsible for all financial market-related activities. Chum was also part of the management group responsible for the integration of the New Zealand operation of Bankers Mr Chum Darvall Trust with Deutsche Bank in 1999. Chief Executive Officer, Prior to his first appointment at Deutsche Bank, Chum worked in the Deutsche Bank, Australia/ New Zealand financial markets divisions of Westpac (1985–1994) and BA Australia Ltd (1981–1985), a subsidiary of Bank of America. Chum is a council member for the Business Council of Australia. Board memberships include Wilson HTM, Australian Financial Markets Association (AFMA), Centre for Independent Studies, Australian Theatre for Young People, the Financial Markets Foundation for Children and the Victor Chang Cardiac Research Institute (VCCRI). Chum is married to Belinda and they have four children.

Mr Robert G Elstone was appointed Managing Director and CEO of the Australian Securities Exchange (ASX) in July 2006, having previously been Managing Director and CEO of the Sydney Futures Exchange between 2000 and 2006. Robert’s career spanned investment banking in the 1980s and public company CFO roles in the 1990s, prior to his leadership roles in both exchanges in the current decade. At the time of his appointment to the ASX, Robert was a non-executive director of the National Australia Bank and an inaugural member of the Board of the Commonwealth Government’s Future Fund, roles he relinquished at the time of his ASX appointment. Between 2007 and 2009 Robert chaired the Federal Treasurer’s Financial Sector Advisory Council (FSAC). Mr Robert Elstone Managing Director and Chief Robert is a graduate of the Universities of London (BA Hons), Manchester Executive Officer, Australian (MA Econ) and Western Australia (M Com) and has completed the senior Securities Exchange executive development programs at the Harvard and Stanford Graduate Schools of Business. He is an Adjunct Professor in Finance within the Faculty of Economics and Business at the University of Sydney, and is an advisory board member for the Centre for Applied Macroeconomic Analysis at the Australian National University as well as for the Macquarie University Applied Finance Centre. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 170

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Dr David Gruen is Executive Director, Macroeconomic Group, Australian Treasury. He joined the Treasury in Jan 2003. Before that, he was Head of Economic Research Department at the Dr David Gruen Reserve Bank of Australia, May 1998 to Dec 2002. He worked at the Executive Director, Reserve Bank for thirteen years, in the Economic Analysis and Economic Macroeconomic Group, Research Departments. With financial support from a Fulbright Australian Treasury Postdoctoral Fellowship, he was visiting lecturer in the Economics Department at the Woodrow Wilson School at Princeton University from August 1991 to June 1993. Before joining the Reserve Bank, he worked as a research scientist in the Research School of Physical Sciences at the Australian National University. He holds PhD degrees in physiology from Cambridge University, England and in economics from the Australian National University.

Mr David Hartley joined Sunsuper with over 25 years of practical experience in Australian and international investment markets, where he has been successful in both managing money and also in investment consulting. Immediately prior to joining Sunsuper he was the Director of Investment Consulting at Russell Investment Group, and before that he was the Chief Investment Officer at Mercer. At Russell, David was also responsible for consulting to Sunsuper. Mr David Hartley Chief Investment Officer, Sunsuper Pty Ltd ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 171

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Mr David Hoare is Chairman of Principal Global Investors (Australia) Ltd a subsidiary of the USA-based Principal Financial Group, a Fortune 500 company. Formerly, he was Managing Director then Chairman of Bankers Trust Australia Ltd, Chairman of Pioneer International Ltd, a director Hanson Plc, and a Board member of Lend Lease Corporation Ltd and Comalco Ltd. He has also been extensively involved in the public sector, particularly in Mr David Hoare Chairman, Principal Global telecommunications, as Chairman of Telstra, and a Director of OTC. He Investors (Australia) Ltd has served as a Director of CSIRO, a Trustee of the Sydney Opera House, and Pro Chancellor of The University of Sydney. Between 2000 and 2006 he was Chairman of the ASX Supervisory Review Ltd, having been the first President of the Takeovers Panel, Deputy Convener of CASAC 1, and Convener of CASAC 2.

Ms Belinda Hutchinson AM is a Non-Executive Director of QBE Insurance Group Ltd, and St Vincents & Mater Health Sydney. Belinda was previously a director of Telstra Corporation Ltd, Coles Myer Ltd, Energy Australia Ltd, TAB Ltd, Crane Group Ltd, Snowy Hydro Trading Ltd and Sydney Water Corporation. She was President of the Council of the State Library of New South Wales in 2005–2006. Belinda was previously an Executive Director of Macquarie Bank. From 1993 to 1997, she was the Head of Macquarie Underwriting Ltd. From 1992 to 1993 she was Director of Client Service. From 1981 to 1992, Ms Belinda Hutchinson Belinda was a Vice President at Citibank Australia. AM Belinda holds a Bachelor of Economics Degree from the University of Non-Executive Director, QBE Sydney and is a Fellow of the Institute of Chartered Accountants in Insurance Group Ltd Australia. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 172

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Mr Kim Ivey is the founder and Managing Director of Vertex Capital Management Ltd. He has 24 years experience in stock broking, corporate finance, asset consulting and investment management. Vertex Capital Management is a specialist investment group designing and managing innovative investment funds for sophisticated Australian and global investors. Prior to establishing Vertex in 1998, Kim spent five years as a Senior Portfolio Manager and the Head of Risk Management with Commonwealth Financial Services (CFS), the investment management division of the Commonwealth Bank of Australia. He and his team quantitatively managed a $600 million equity portfolio, advised CFS portfolio managers on derivative-based hedging techniques, tactical asset allocation, and performance attribution for CFS’s $10 billion+ multi-asset portfolios. Mr Kim Ivey Kim served as the National Practice Leader of asset consulting for Towers Chairman, Alternative Perrin Australia in 1992 and 1993. Investment Management From 1989 to 1992, Kim was Vice President of Corporate Finance at Association, and Managing Director, Vertex Capital Citibank Australia. Management Ltd From 1985 to 1989, Kim worked as an Institutional Client Adviser with Merrill Lynch International. Kim is a member of the Securities Institute of Australia, a founding member of the Alternative Investment Management Association chapter in Australia, and its current Chairman (2004 to present).

Dr John Laker AO is the Chairman of the Australian Prudential Regulation Authority (APRA). APRA was established in 1998 as an integrated supervisor of banks and other deposit-taking institutions, insurance companies and superannuation funds. Dr Laker is a graduate of Sydney University and the London School of Dr John Laker AO Economics. Chairman, Australian Prudential Regulation Authority Dr Laker started his professional life in the Commonwealth Treasury and, after post-graduate studies, worked at the International Monetary Fund in Washington DC for four years. He joined the Reserve Bank of Australia in 1982 and, over a 21-year career, held senior positions in all of the Bank’s major policy areas. He was the Bank’s Chief Representative in Europe, based in London, from 1991 to 1993; Assistant Governor (Corporate Services) from 1994 to 1998; and Assistant Governor (Financial System) from 1998 to 2003. He was also an APRA Board member and Deputy Chairman of the Payments System Board of the Reserve Bank from 1998 to June 2003, when he was appointed to run APRA. Dr Laker is APRA’s representative on the Payments System Board, the Council of Financial Regulators and the Trans-Tasman Council on Banking Supervision. Dr Laker was appointed an Officer of the Order of Australia (AO) in the 2008 Australia Day Honours for services to the regulation of the Australian financial system. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 173

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Ms Catherine Livingstone AO, after qualifying as a chartered accountant and working with PriceWaterhouse in Sydney and London, joined the Nucleus Group and spent 20 years working in the field of implantable medical devices, including six years as CEO of Cochlear Ltd from 1994 to 2000. Catherine is currently a Director of Macquarie Group Ltd, Telstra Corporation Ltd and WorleyParsons Ltd. She is also a member of the New South Wales Innovation Council and a director of Future Directions International and The Royal Institution of Australia. Catherine continues to support The Australian Business Foundation (an independent business-sponsored research think tank focused on the concept of innovation-led growth) having been Chairman from 2002 to 2005, and has also served on the Boards of Goodman Fielder Ltd and Ms Catherine Livingstone Rural Press Ltd, as well as having been the Chairman of CSIRO from 2001 AO to 2006 and the President of Chief Executive Women from 2007 to 2008. Non-Executive Director, Telstra Catherine attended the IMD International, Program for Executive Corporation Ltd and Macquarie Bank Ltd Development in Switzerland in 1992, and was the Eisenhower Exchange Foundation Fellow for Australia in 1999.

Mr Ben McCarthy has over 15 years experience in the financial markets and over 10 years with Fitch Ratings. Ben joined Fitch in Sydney in March 1998 as a founding member of Fitch’s Australian Structured Finance team. Ben later moved to Hong Kong as Head of Asia-Pacific Structured Finance for Fitch spending four years in that role. On 1 January 2006 Ben commenced his current role as Head of Australia and New Zealand Structured Finance for Fitch Ratings. Mr Ben McCarthy Managing Director, Fitch Ben currently sits on Fitch’s Global Structured Finance Criteria Committee Ratings Australia Pty Ltd and is a member of the National Committee of the Australian Securitisation Forum. He has extensive experience in property and structured finance across a wide range of asset classes including RMBS, ABS, CMBS and Future Flow. Prior to joining Fitch, Ben worked as a debt markets Research Analyst for UBS AG in Sydney Australia, producing regular research publications for clients. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 174

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Mr Ian Macfarlane AC was Governor of the Reserve Bank of Australia from 1996 to 2006, and inaugural Chairman of the Council of Financial Regulators. Prior to joining the Reserve Bank, he had worked at Monash University, the Institute for Economics and Statistics at Oxford University, and at the Organisation for Economic Co-operation and Development in Paris. Since leaving the Reserve Bank, he has served on several Australian public company Boards, been a member of the International Advisory Board of Goldman Sachs, and become a Professorial Fellow at Melbourne University and Melbourne Business School. Mr Macfarlane was elected a Fellow of the Academy of Social Sciences in Australia and has been the recipient of honorary doctorates from five Australian universities. Mr Ian Macfarlane AC Former Governor of the In 2006 he delivered the Boyer Lectures. He has been a director of the Reserve Bank of Australia, and Lowy Institute since its inception in 2003. Director, Woolworths Ltd, ANZ Banking Group Ltd and Leightons Holdings Ltd

Mr David Murray AO joined the Commonwealth Bank in 1966 and was appointed Chief Executive Officer in June 1992, retiring from this position Mr David Murray AO in 2005. Chairman, Future Fund The Commonwealth Bank is one of Australia’s four major banks. It was founded in 1911 by the Australian Government and its privatisation was completed in 1996. The Bank is one of Australia’s top 10 listed corporations. In David Murray’s 13 years as Chief Executive, the Commonwealth Bank has transformed from a partly privatised bank with a market capitalisation of $6 billion in 1992 to a $49 billion integrated financial services company, generating in the process total shareholder returns (including gross dividend reinvestment) at a compound annual growth rate of over 24%, one of the highest total returns of any major bank in Australia. In November 2005 the Australian Government announced that Mr Murray would be Chairman of the Future Fund. The Fund’s objective is to invest budget surpluses to meet the long term pension liabilities of government employees. Mr Murray is a life member of the Financial Markets Foundation for Children and is on the Advisory Council of the Global Foundation. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 175

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Mr Stephen Roberts was appointed Country Corporate Officer for Citi Australia effective April 2008. Stephen is also CEO of the Institutional Clients Group for Australia and New Zealand. He has held this role since 2003 and has, over this period, overseen the rapid growth of this business for Citi in Australia and New Zealand. Prior to taking this role, he was Citi’s Asia-Pacific head of Fixed Income. Stephen began his career with Salomon Brothers in 1984 as an Investment Banking Associate in New York. In 1985 he was transferred to Sydney and was given responsibility for opening and heading the firm’s Melbourne office in 1989. In 1992, he transferred to London as Director of European Capital Markets. Stephen is an Adjunct Professor of Finance at the University of Sydney and sits on the Board of Advice to the Faculty of Economics and Finance. He is Mr Stephen Roberts a Council and Board member of the Australian Bankers’ Association, and Citi Country Officer and Chief sits on the Board of the Australian Financial Markets Association and the Executive Officer, Institutional Australian American Association. Clients Group Australia/New Zealand, Citi Australia Before joining Salomon Brothers, Stephen held positions with the Australian Treasury and the Australian Foreign Service as Vice Consul in New York. He holds a Bachelor of Economics degree from the Australian National University.

Mr Graeme Samuel AO is Chairman of the Australian Competition and Consumer Commission (ACCC). He took up this position in July 2003. Until then he was President of the National Competition Council, Chairman of the Melbourne and Olympic Parks Trust, a Commissioner of the Australian Football League, a member of the Board of the Docklands Authority, and a Director of Thakral Holdings Ltd. Mr Graeme Samuel AO Chairman, Australian He relinquished all these offices to assume his position with the ACCC. Competition and Consumer Commission Mr Samuel is also an Associate Member of the Australian Communications and Media Authority. He is a past President of the Australian Chamber of Commerce and Industry, a past Chairman of Playbox Theatre Company and Opera Australia, a former Trustee of the Melbourne Cricket Ground Trust and former Chairman of the Inner and Eastern Health Care Network. Until the early 1990s he pursued a professional career in law and investment banking, from which he retired to assume a number of roles in public service and company directorships. Mr Samuel holds a Bachelor of Laws (Melbourne) and Master of Laws (Monash). In 1998 Mr Samuel was appointed an Officer in the General Division of the Order of Australia. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 176

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Mr Hector Sants is the Chief Executive of the Financial Services Authority (FSA) in the UK. Prior to his appointment as CEO in July 2007, he was a Managing Director of the FSA responsible for Wholesale and Institutional Markets. In this role he had responsibility for all regulated markets, the related infrastructure such as clearing and settlement, the operation of the UK Listing Rules, the regulation of firms or groups which conduct primarily wholesale or institutional market business and the associated policy Mr Hector Sants framework. Chief Executive Officer, Financial Services Authority, UK Hector joined the FSA in May 2004 from Credit Suisse First Boston (CSFB) where he was European Chief Executive and a member of the firm’s Executive Board. Prior to joining CSFB in 2000, when the firm merged with Donaldson, Lufkin & Jenrette he held a number of senior investment banking management roles at DLJ and UBS in both London and New York. He was a member of the FSA Practitioner Panel and was previously a Board member of, among other bodies, the SFA, the London Stock Exchange and LCH.Clearnet.

Senator the Hon Nick Sherry is the Minister for Superannuation and Corporate Law in the Australian Government. He is responsible for all superannuation policy and administration matters, including taxation and prudential regulation of superannuation funds.

Senator the Hon Nick His corporate law responsibilities include governance and insolvency Sherry issues as well as aspects of financial market conduct, disclosure, investor Minister for Superannuation protection and supervision and oversight of ASIC. and Corporate Law Other areas which he covers include financial literacy and the Royal Australian Mint. Nick was previously Shadow Minister responsible for superannuation and has also been Shadow Assistant Treasurer. He was also a Parliamentary Secretary during the Keating Labor Government. Nick chaired the Senate Select Committee on Superannuation in the former Labor Government and was also Deputy Chair of the Senate Select Committee on Superannuation and Financial Services. His more than 20 years’ experience in the Australian superannuation system has given him deep knowledge and interest in the design and operation of superannuation and pension systems. The Minister has been a Senator for Tasmania since 1990. He is based in Devonport on Tasmania’s North West Coast. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 177

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Mr Gary Simon has over 30 years of experience in the financial services industry including a broad background in funds management, project finance, corporate banking, and publicly-listed industrial companies. During this period, Gary has gained significant experience in investment evaluation and ongoing management of substantial assets, including complex financial and corporate transactions. He has lived and worked overseas, gaining experience in negotiation of joint-venture arrangements in Asia and Europe and completion of a business acquisition in the USA. Gary is currently Head of Investments Group at ABN AMRO Australia. He is responsible for ABN AMRO’s domestic funds management business with particular focus on infrastructure, property and credit asset classes and is the ABN AMRO-appointed Board member to certain principal investments Mr Gary Simon of the group. Head of Investments Group, Global Markets, ABN AMRO He holds a Master of Commerce from the University of NSW, is an Australia Ltd Associate of the Institute of Chartered Accounts in Australia and a Fellow of the Institute of Company Directors in Australia. Gary enjoys reading biographies and exploring the field of personal development. Other interests include sailing, skiing, tennis and 4WD adventures. More recently Gary has qualified as a PADI Open Water diver.

Mr Gary Sly started his role with ANZ in 2002. He joined the ANZ team from Credit Suisse First Boston (CSFB) bringing with him over 25 years experience in various areas of banking, including over 20 years in the capital markets. Gary has been credited with executing notable transactions for clients such as Ford Credit, St.George Bank, Members Equity, GMAC, DaimlerChrysler and the Commonwealth Bank of Australia (CBA). He has experience across a very broad range of collateral types in various jurisdictions, including Australia, the USA, the UK and NZ. Prior to CSFB, he worked with CBA where he was involved in executing Mr Gary Sly securitisation transactions for CBA’s own balance sheet. Previously, he Director, Debt Capital Markets, worked with Colonial State Bank where he gained extensive experience in Global Markets, ANZ Banking securitisation and wholesale funding. Group Ltd Gary graduated in Law from the University of Technology, Sydney. He is also an active member of the Australian Securitisation Forum, lecturing for the ASF Diploma Course and sitting on committees (for example, the Market Standards and Practices Committee). ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 178

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Mr Michael Smith OBE is Chief Executive Officer of Australia and New Zealand Banking Group Ltd (ANZ) and a director of ANZ National Bank. ANZ is a leading financial services group in Australia and New Zealand with a significant presence in Asia. Until June 2007, Michael was President and Chief Executive Officer of The Hong Kong and Shanghai Banking Corporation Ltd, where he had a 29-year career. He was also Chairman, Hang Seng Bank Ltd, Global Head of Commercial Banking for the HSBC Group and Chairman, HSBC Bank Malaysia Berhad. Previously, Michael was Chief Executive Officer of HSBC Argentina Holdings SA and was subsequently appointed Chairman of HSBC in Argentina in 2000. Michael is a Member of the Asia Business Council, the Business Council of Mr Michael Smith OBE Australia and the Australian Bankers’ Association Council. Michael is also a Chief Executive Officer member of the Chongqing Mayor’s International Economic Advisory and Director, ANZ Banking Council and a Fellow of The Hong Kong Management Association. He is a Group Ltd director of the Financial Markets Foundation for Children and a Member of the Financial Literacy Advisory Board. Michael was made an Officer of the Order of the British Empire in 2000 and a Chevalier de l’Ordre du Merite Agricole in 2007.

Dr John Stuckey has spent the last 30 years serving Australian corporates as a Management Consultant with McKinsey & Company. He retired as a Partner of McKinsey two years ago and now serves as a Senior Advisor, as well as pursuing other professional interests. During his time with McKinsey John advised senior executives on strategic and organisational issues across a wide range of companies and industries, though with concentrations in mining, financial services, telecommunications and airlines. John served as Managing Partner for this part of the world, was chairman of Asia and a member of the Global Board. Prior to joining McKinsey John taught economics at Sydney University after completing a PhD in Business Economics at Harvard.

Dr John Stuckey Senior Advisor, McKinsey & Company, and Chair, ASIC’s External Advisory Panel ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 179

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Mr Greg Tanzer’s appointment as Secretary General of the International Organization of Securities Commissions (IOSCO) commenced on 1 January 2008. IOSCO is recognised as the leading international policy forum and most important international cooperative forum for securities regulatory agencies. IOSCO’s members regulate more than 90% of the world’s securities markets in more than 100 jurisdictions. Previously, Greg was Executive Director, Consumer Protection and International and Regional Commissioner (Queensland) for ASIC. In that capacity he was responsible for managing ASIC’s consumer protection education and compliance operations, receipt and analysis of reports of corporate misconduct from liquidators and the public, international relations, and coordinating the activities of ASIC’s regional offices. In his international relations role with ASIC, he served as Chairman of IOSCO’s Standing Committee 5 on the Regulation of Collective Investment Schemes (mutual funds) from 1997 to 2003. He served as Mr Greg Tanzer Secretary General, Chairman of its Implementation Task Force, which is responsible for International Organization of developing and maintaining IOSCO’s standards for securities regulation, Securities Commissions from 2006 to the present. Greg also served as a member of the Secretariat for the Inquiry into the Australian Financial System—known as the ‘Wallis’ inquiry—which in 1997 reviewed the regulatory framework for financial services in Australia and led to the creation of ASIC and the Australian Prudential Regulation Authority.

Mr Peter Thompson is a broadcaster with ABC television. He hosts Talking Heads, a biographical program about the lives of prominent Australians that is now in its fifth year. He was the long time presenter of Radio National’s Breakfast and the AM program on ABC Radio. Peter is a Professor and Fellow of the Australian and New Zealand School of Government, where he teaches on communication and public policy, and is an adjunct Professor at Macquarie University’s Department of International Communication. He is also Director of the Centre for Leadership—which provides communication advice to public and private sector organisations. Peter is the author of several books about communication, including Mr Peter Thompson Persuading Aristotle: the timeless art of persuasion in business, negotiation ABC television and radio and the media. He holds a Master of Public Administration from Harvard, broadcaster an MBA from the Australian Graduate School of Management and a BA from the Australian National University. ASIC Report 15.5:Layout 1 19/05/09 10:43 AM Page 180

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Mr Andrew Twyford is the General Manager, Treasury and Securitisation, for the Challenger Financial Services Group’s Mortgage Management business. He has been employed by Challenger Mortgage Management since 2000 and prior to taking on this existing position was its Chief Financial Officer. Andrew is responsible for the treasury and securitisation functions which includes the Challenger Millennium and Challenger Titanium Securitisation programs and is a member of the Executive Management teams at both a Mr Andrew Twyford divisional and group level. General Manager, Treasury and Securitisation, Challenger Andrew has driven Challenger’s mortgage funding platform to be Australia’s Financial Services Group Ltd most prolific issuer of residential mortgage-backed securities transactions, and has been responsible for bringing to market a number of innovative structures as well as diversifying and significantly widening the business’ investor base. Prior to joining Challenger, Andrew was the Financial Controller for HSBC Asset Management in Australia. He holds a Bachelor of Business degree and is an Associate of the Institute of Chartered Accountants in Australia.

Mr Martin Wheatley, JP is the Chief Executive Officer of the Securities and Futures Commission (SFC) in Hong Kong. Martin became the Executive Chairman of the SFC on 1 October 2005 and Mr Martin Wheatley was appointed by the HKSAR Chief Executive as the SFC’s first Chief Chief Executive Officer, Executive Officer on 23 June 2006. Securities and Futures Commission, Hong Kong Prior to joining the SFC, Martin was Deputy Chief Executive of the London Stock Exchange. Martin was also Chairman of the FTSE International and sat on the Listing Authority Advisory Committee of the Financial Services Authority of England. Martin qualified as an accountant in 1984, has a first degree in Philosophy and an MBA. ASIC SS09Reportcover(18.5):Layout119/05/095:17PMPage

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