April 2008

Contents:

 

LEGISLATION Law Commission Privacy Study Paper Securities (Local Authority Exemption) Amendment Bill Reported Back Securities Amendment Regulations 2008 Interim Report On Financial Advisers Bill Consultation On Stapled Securities New Organised Crime Agency

SNIPPETS SIVS: Is The Party Over? Introduction To The Internal Ratings Based Under Basel Ii Developing Carbon Structured Products: Peter Zaman Insolvency Law Reform: Everything Else You Wanted To Ask Cross-Border Insolvency And The Uncitral Model Law Australia - Anti-Money Laundering And Counter-Terrorism Financing Act Developments - A Quarterly Update Joint Ventures In The Australian Resources Sector After The Gold Rush Why Banks' Regulatory Capital Requirements Need To Be Raised Cross-Border Insolvency: The Future For Australia Australian Securitisation- Sensible Basel Ii Contracts Beat Policy Sons Of Gwalia Versus Shareholder Subordination

The Law Commission released a study paper in January 2008 entitled Privacy:  Concepts and Issues.  The study paper is the first stage in a four stage review of New Zealand's privacy laws, which the Commission is currently conducting.  The study paper sets out the framework for the later stages of the review.  Specifically, the Commission's aims in this first study paper are to:

• provide a conceptual framework for the privacy review as a whole;
• review developments that have an impact on privacy, with a focus on social attitudes and values, emerging technologies, and international trends;
• indentify key issues for exploration in the later stages of the review; and
• identify the implications for New Zealand civil, criminal and statute law of the Commission's conceptual approach to privacy and its review of developments affecting privacy.

The Commission has not published recommendations at this stage, but expects to do so at later stages of the review.

The Securities (Local Authority Exemption) Amendment Bill was reported back from the Commerce Committee on 11 March 2008.  If passed, the Bill would exempt local authorities from the full disclosure requirements of the Securities Act 1978 when issuing debt securities to the public.  If the Bill is passed, local authorities will not need to produce a prospectus signed by all councillors and may produce only an investment statement, with a certificate signed by two councillors.  The Commerce Committee has recommended that the Bill be passed, but that the proposed exemptions be subject to the further conditions, including that the local authority be required to refer to its most recent audited accounts when issuing debt securities.

The Securities Amendment Regulations 2008 came into force on 10 April 2008.  The Amendment Regulations amend the information relating to investment advice that is required to be included in investment statements, as a consequential change resulting from the changes in the investment adviser disclosure regime that came into force on 29 February 2008.  Investment statements produced after 10 April 2008 must reflect the new investment adviser disclosure regime by containing a statement in the form prescribed in the Amendment Regulations.

The Finance and Expenditure Committee released an interim report on the Financial Advisers Bill on 17 April 2008.  In its interim report, the Committee expressed concerns that the scope of the Bill as currently drafted is too wide and could apply to people who ought not be caught by the new regime.  The Committee also released a discussion document prepared by the Minister of Commerce, which provides more detail about options for narrowing the scope of the Bill and also suggests changes to the Bill's proposed institutional arrangements.  Submissions on the Bill have been reopened, and now close on 16 May 2008.  Copies of the Committee's interim report and the associated discussion document are available from www.parliament.govt.nz.

Following the government's announcement in February that it would seek to change the tax treatment of stapled securities (instruments with both a debt component and an equity component), draft legislation was published on 23 April 2008 that would give effect to this proposal.  The government is inviting submissions on the draft legislation, which is available from www.taxpolicy.govt.nz.  The closing date for submissions is 30 May 2008.

On 1 April 2008 the Minister of Justice announced that a new Organised and Financial Crime Agency New Zealand ("OFCANZ") would be launched on 1 July 2008.  OFCANZ will be a unit within the New Zealand Police, and will focus on organised crime and serious financial crime.  The Serious Fraud Office will be merged with OFCANZ.

The January 2008 issue of the Butterworths Journal of International Banking and Financial Law contains three articles of interest.

• The first article is entitled SIVs: is the party over? by Philip Hertz, Neil Hamilton and Gabrielle Ruiz.

  This article focuses on the available restructuring and enforcement options for structured investment vehicles ("SIVs") with an emphasis on the benefits of receivership from an English perspective. The authors' views are particularly topical given the current conditions in the credit markets and their direct impact on SIVs.

  SIVs are investment companies that purchase highly-rated debt securities and fund them through issuing capital notes, commercial paper, medium-term notes and occasionally mezzanine debt. Due to their typical structure as bankruptcy remote entities, the SIV itself, its investors and transaction counter-parties agree not to commence insolvency proceedings and have limited recourse to the assets of the SIV. Instead they rely on a security trustee to enforce the security. Once enforcement proceedings are triggered the security trustee takes over management of the portfolio and is forced to liquidate it according to a timetable specific to the SIV.

  There is also scope under English law for the security trustee to appoint a receiver. This provides a flexible contractual mechanism for secured creditors to facilitate the enforcement of their security. Therefore rather than forcing the immediate liquidation of the portfolio they can attempt to effect a refinancing or a more orderly realisation of the assets. The authors' support this approach and point to Cheyne Finance plc [2007] EWHC 2402 (Ch), where it is being applied to an asset portfolio of approximately US$6 billion.

  The article concludes by proposing that the future of the SIV market will depend on SIVs' abilities to manage the current liquidity crunch. Further, it suggests that receivers will play a crucial role in creating a stable platform to allow restructurings, either by conducting an orderly realisation of the portfolio or by pursuing refinancing options.

• The second article is entitled Introduction to the internal ratings based approach under Basel II by Irina Molostova. This article gives an overview of the Internal Ratings Based Approach ("IRB") adopted under Basel II and its key components in non technical terms.

  Basel II replaces the original Basel Accord signed in 1988 with the intention of creating a better framework for regulating bank capital and implementing a system sensitive to credit risk, as original accord was regarded as inadequate at properly managing risk. The need for regulatory framework under Basel II (developing the IRB) to create sound lending and credit risk management policies arose both due to most banks having created their own internal rating system and due to the rapid development of international banking in the 1990s.

  A key foundation of Basel II is that any bank adopting the IRB ("IRB banks") must have sufficient capital to prevent insolvency. Sufficient capital includes the expected losses and unexpected losses a bank will incur (ie - a potentially large loss that occurs infrequently above the amount of expected losses).

  Basel II includes methods of calculating expected losses relying on the probability of default and the estimate of loss amount owed at time of default. As risk for an exposure can fluctuate, credit risks associated with an exposure must be reassessed at least annually, high risk exposures will require more frequent assessment, and if any new information regarding an exposure arises the risk parameters must also be reassessed - all placing an increased burden on IRB banks' internal resources to monitor their risks.

  The capital requirements of banks will be represented by banks' unexpected losses. A system dividing exposures into different classes to calculate the unexpected loss is provided. Basel II splits exposures into seven groups (corporate, sovereigns, banks, retail, equity, securitisation and non-credit obligation assets), each with their own associated risks and risk drivers.

  As the essential role of the IRB is calculating capital requirements, the system used to generate internal ratings by a bank must be consistent with their internal use. Where there is a gap between a bank's IRB estimates and estimates used for internal purposes the bank must demonstrate the reasonableness of that gap to its regulator.

  The author commends Basel II for the introduction of a scheme that more accurately calculates credit risks and reflects that credit risk in capital requirements of the bank. The author also predicts that gaps existing between IRB and internal methods of risk calculation by a bank will decrease over time.

  (Note: banks may only apply the IRB if they receive express permission from their regulators).

• The third article is entitled Developing carbon structured products by Peter Zaman

  Economics and environmental sustainability are the two key drivers behind attempts to develop structured products using climate change mitigants as their underlying asset. Such products are unique in that environmental benefit is a driver as well as the usual financial and economic concerns. The development of structured products in carbon is illustrative of the idea that it is possible to combine economic rewards with efforts to reduce the effects of global warming.

  The coming into force of the Kyoto Protocol and the European Union's Emissions Trading Scheme (the "EU ETS") in 2005 provided an opportunity to establish a market price for carbon allowances. By allowing market forces to determine the cost of these carbon credits, the EU ETS generates a cost of compliance for CO2 emissions.

  By linking the EU ETS to the Kyoto Protocol's emission mechanisms, the EU ETS has enabled emitters a choice when managing their carbon compliance obligations by trading either European carbon allowances or carbon credits acquired under the Kyoto processes. The cost of Kyoto-based carbon credits is currently lower than the price of EU allowances. This has driven an estimated €5 billion in investment into the mechanisms of Kyoto in 2006 and created arbitrage in the emissions markets.

  This has lead to the creation of a range of vanilla derivative instruments in carbon, including over-the-counter physically settled carbon forwards, options contracts and exchange traded spot and futures contracts.

  The development of such instruments however has been slowed by infrastructure and legal impediments. The major infrastructure problem is that to ensure credits are not double sold or used twice they are tracked by an international transaction log. However the EU ETS and Kyoto use separate tracking systems and until these are linked, credits cannot be safely traded between the two schemes.

  Additionally. there are legal impediments around the classification of credits. No legislative attempt has been made to classify them as either intangible property, a good, a licence or permit to pollute or an international regulatory environmental commodity. This lack of classification creates problems when trading cross border, on insolvency of a holder, and in creating a security interest over the instruments.

  During 2007 there was increasing interest in developing carbon structured products and products are currently being designed to overcome the legal and infrastructure problems outlined. As this is achieved and the market matures, greater certainty and confidence will follow, which can only benefit the development of carbon structured products.

The February 2008 Company and Securities Law Bulletin contains the article Insolvency law reform: everything else you wanted to ask by Scott Barker.

This article is an update to an earlier paper given by the author at the LexisNexis Corporate Insolvency Law Conference held in February 2008. It addresses recent changes to the law of company liquidations in Part XVI of the Companies Act 1993. The article is split into two parts. The first part considers changes to the appointment of liquidators, related party voting and reporting obligations. Part two looks at litigation rights and funding.

In relation to changes concerning appointment of liquidators, section 241(2) has been amended to provide that a liquidator may now be appointed by a resolution of creditors at a watershed meeting where an administrator's proposals have been rejected by the creditors. Section 241AA has been inserted to counter situations where directors and creditors associated with insolvent companies have been able to avoid investigation and potential litigation through passing special resolutions appointing liquidators. Under this new provision the court will consider conflicts of interest, bias, impropriety, misconduct and the wishes of creditors in coming to its decision.

The author then goes on to consider changes to notice and reporting requirements. Section 243 has been amended to ensure that a liquidator must give notice of a meeting to all creditors regardless of the size of the anticipated dividend. Previously this could be avoided if the anticipated dividend was below 20c in the dollar. In relation to related party voting section 245A has been inserted. This section grants the court wide powers to review voting at creditors' meetings where the outcome may have been influenced by related party voting. Amendments to notice requirements also include an amendment to section 255, where now a liquidator must prepare a list of every known creditor containing each creditor's address and send this to every known creditor, shareholder and the Registrar of Companies.

The article provides a detailed explanation to the newly inserted section 280. This has been inserted to address conflict of interest situations between the company and the liquidator and is designed to eliminate those with actual or apparent conflicts of interest from taking insolvent liquidation appointments. Sections 285 and 286 have been amended and set out the basis and procedure for taking action against liquidators where duties have been breached.

Part two of the article considers changes that are intended to assist liquidators in the funding and pursuit of recoveries.  New section 260A entitles liquidators to assign the rights to pursue insolvent and undervalue transactions, but is subject to a number of limitations. This change brings New Zealand into line with similar legislation in England and Australia.

Important amendments have been made to the priority rules contained in the Seventh Schedule to the Companies Act. Now, any creditor who provides additional funds to preserve or protect assets, or to fund litigation undertaken by the liquidator, gets priority from realisations; not only to the extent of that funding, but also in respect of the creditor's claim. Linked to this change are amendments to section 269, which have the purpose of enabling liquidators to control litigation rights that they consider are either vexatious or are not worth pursuing, but which creditors or directors of the company wish to acquire to pursue for ulterior purposes.

The final area of reform considered is a brief summary of the effect of the newly inserted section 271A. The purpose of this change is to enable all creditors and any liquidator who is not a party to the application for a pooling order to have sufficient information in order to make a fully informed decision in respect of the order.

The Issue 2, February 2008 Australian Corporate News contains the article Cross-Border Insolvency (And The UNCITRAL Model Law) by Paul Nicols and Pouyan Afshar.

Australia has recently introduced legislation into Parliament which will enact the UNCITRAL Model Law on Cross-Border Insolvency.  The concept of centre of main interests ("COMI") is central to the recognition procedures in the Model Law.  The recent decision of the United States Bankruptcy Court in Bear Stearns provides guidance as to the application of the COMI concept which is likely to be followed by Australian Courts

The Bear Stearns decision clarifies the operation of the Model Law presumption that the debtor's COMI is where its registered office is located by providing that the presumption will only operate where there is no dispute as to the place of the debtor's COMI.  Where there is dispute, the location of the debtor's registered office is merely evidence which can be outweighed by evidence to the contrary.  The fact that the foreign representative has the burden of proving the location of the debtor's COMI was also clarified. 

If this decision is applied in Australia, financiers, creditors, and insolvency practitioners may be able to defeat applications for recognition of a foreign proceedings as a "foreign main proceeding" or "foreign non-main proceeding" more easily, provided that they can point to some evidence to rebut the presumption.

The facts

Joint provisional liquidators ("JPLs") were appointed to two Bear Stearns hedge funds registered in the Cayman Islands ("the funds").  A bankruptcy proceeding was initiated in the Grand Court of the Cayman Islands to liquidate the funds.  The issue for the court was whether the debtor's COMI was located in the Cayman Islands.  The JPLs, in support of the proposition that it was, argued that no interested parties had objected to the Cayman Islands proceedings being recognised as the "foreign main proceedings", and that here was a presumption that the debtor's COMI was the Cayman Islands as that was where the funds were registered.

Both arguments were rejected.  The debtor's COMI was held to be the United States as there were no employees or managers in the Cayman Islands, the funds' investment manager was situated in New York, the funds' administrator, books and records were located in the United States, prior to the proceedings, the liquid assets of both funds were located in the United States, the majority of investors, although registered in the Cayman Islands, had little profile in the Cayman Islands and the investor registries of the funds were located in Ireland with their accounts receivable situated in Europe and the United States.

Conclusion

The decision provides that the purpose of the presumption as to a debtor's COMI is to allow for prompt action where the location of the debtor's COMI is not disputed.  In cases where there is dispute the presumption will cease to operate and the court must make a determination on the evidence before it.  The significance of this decision arises by virtue of its departure from the previous position under the SPhinX case, in which it was held that where there was no objection from interested parties, even where there was compelling evidence to the contrary, the presumption would continue to operate.

The February 2008 Australian Banking and Finance Law Bulletin contains two articles of interest.

The March 2008 issue of KangaNews contains the article After the gold rush by Laurence Davison.

The article addresses the role played by Kauri Bonds in the past year and how that role may change in the current economic climate.

The year 2007 saw the boom of Kauri bond issuances into the New Zealand market. Banks developed an appetite for these types of securities as they were seen as more liquid than government bonds and offered a more attractive yield. In the present economic downturn, Davison notes that the jury is still out as to the extent to which the domestic investor base for Kauri bonds can be broadened and deepened.

Davison explains that one of the main reasons for obtaining Kauri bonds was because of their liquidity. If the Kauri market does not exhibit this, a significant reason for holding them evaporates. Davison finds that the degree of liquidity of Kauri bonds is of differing   concern among institutional fund managers.

The author finds that liquidity is not the only area in which New Zealand based fund managers wish to develop a degree of certainty before committing significantly to the Kauri sector. Davison sums up the Kauri position as being between two pillars. In stressful times government bonds are a safe option exercised in New Zealand.  When investors are seeking higher yield positions, the appeal of government proxy securities (like Kauri bonds) falls.

The author explains that the above is exhibited in the ongoing debate about appropriate benchmarks for New Zealand investors. At present there is no firm view on the matter, with investors making their own decisions on an ongoing basis. Mark Brown from AllianceBernstein agrees there is a trend towards swap benchmarking, reducing the appeal of triple A Kauri bonds. Amongst the differing views on benchmarks, there is only one consensus, according to Davison, and that is that a 100 per cent government bond benchmark is inadequate.

Davison has uncovered varying market outlooks from institutional lenders. Even when fund managers' overall market direction outlooks coincide, their courses of action prove very different.

Davison explains that this uncertainty in the market makes it difficult to orchestrate and price deals. There is still speculation as to whether the bottom of the fall-out has been reached. That means that any investment approach must be of a cautious nature.  Institutional fund managers are uncertain as to when the buying will start to return, and as a result are waiting for an increase in confidence before they start looking at returning to the market.

The February 2008 issue of Butterworths Journal of International Banking & Financial Law contained two articles of interest.

The March 2008 issue of the International Financial Law Review contained two articles of interest.

• The first article entitled  Australian securitisation - sensible Basel II by Berkeley Cox and Paul Smith describes some of the important differences between Basel II and the new Prudential Standard APS 120: Securitisation (APS 120), which came into effect on January 1 2008.

  APS 120 places some restrictions on authorised deposit takers ("ADIs"). The authors note that this may give non-ADI sponsored issuers and foreign issuers the opportunity to structure products that would attract investors that ADI sponsored issuers cannot.

  The authors explain that APS formally forbids Australian ADIs to conduct covered bond deals, something that Basel II did not explicitly do. However, foreign ADIs and non ADI sponsored issuers could potentially structure products involving covered bonds for the Australian market.

  Another restriction on ADIs mentioned in the article is that ADIs must not provide implicit support to securitisation vehicles. This is a requirement that does not affect non-ADI sponsored issuers, giving them more flexibility to structure their transactions as they see fit.

  Furthermore, the authors state that Australian ADIs are also prevented from acquiring assets from securitisation vehicles as part of their call options that can be exercised on a particular date without regard to pool size.

  The authors conclude the article noting that the flexibility that is afforded to non-ADIs allow some level of certainty about timing and repayment, which will be of increasing importance in the future.

• The second article, entitled Contracts beat policy by Scott Farrell and Jeremy Green, looks at the recent Australian High Court decision of International Air Transport Association v Ansett Australia Holdings Limited (Ansett).

  This case concerned a contractual clearing-house operated by the International Air Transport Association ("Iata"), which facilitates payments between airlines for the services they supply one another. Ansett was put into administration and Iata sought to enforce its claim against Ansett for a net amount owed to Iata under clearing-house rules. Its administrators sought to enforce Ansett's claims against various individual airline members of the clearing-house. After a ruling in the House of Lords in 1975 regarding the arrangement of the clearing- house, its rules were amended to clarify that no debt ever arises between airlines, but only between each airline and Iata itself. In Ansett the Australian High Court considered   these amended rules.

  The court found in favour of Iata, deciding that debts did not arise between Ansett and the other air service members of the clearing-house. The authors state that it was generally accepted before this decision that a court would most likely uphold a contractual provision purporting to deal with or dispose of property of an insolvent company. The High Court has now confirmed, however, that the contractual terms determine whether a contract gives rise to particular rights or obligations (such as debt). The decision means that no over-arching principle of public policy can be used by a court to rewrite a contract to create a relationship that the parties agreed would not exist.

  The authors consider that the Ansett decision will support the enforceability of flawed asset provisions and strengthen the view that the terms of a contract shall not be rewritten solely because one party has become insolvent.

The March 2008 issue of the Companies and Securities Law Journal, contains an article by Andrew Bilski and Patrick Brown entitled Sons of Gwalia versus shareholder subordination: Fairness versus efficiency. 

The recent High Court of Australia decision in Sons of Gwalia Ltd v Margaretic (2007) 81 ALJR 525; 232 ALR 232; 60 ACSR 292; [2007] HCA 1 determined that in corporate insolvency, a claim by a shareholder for damages arising from a company's misleading or deceptive conduct is a provable debt that ranks equally with the claims of unsecured creditors.  Following this decision, the Federal Government referred the question of shareholder subordination as a matter of general policy in Australia to the Corporations and Markets Advisory Committee for advice on possible legislative reform.

In the light of this development, the authors examine the competing considerations that should be taken into account when determining whether shareholder subordination should apply in Australia. 

The authors begin by looking at some of the justifications for the abrogation of shareholder subordination.  In particular, they discuss the legal arguments put forward in Sons of Gwalia that conceptual consistency in the law is enhanced without shareholder subordination.  In addition, they argue that on a practical level, the capital maintenance doctrine as a major justification for shareholder subordination is increasingly irrelevant in modern corporate finance, particularly when the supposed conflict between shareholders and creditors is reconceptualised more accurately as a conflict between shareholders and the market generally (the authors argue that the imposition of a general policy allowing shareholders to claim as unsecured creditors will result in lenders factoring this added risk into the interest rates they charge on unsecured loans).

Despite these arguments, the authors go on to argue that ranking shareholder claims alongside unsecured creditors is fatal to the efficiency of the insolvency regime.  In particular, they argue that such a state of affairs would result in increased delays, costs and misuse of the administration process by creditors and shareholders alike.  It is also noted, that the likelihood of shareholders bringing Sons of Gwalia-type claims is also significantly increased by recent growth in the popularity of litigation funding and the increased accessibility of class actions to plaintiffs.

Finally, the authors note that Sons of Gwalia has significant, if uncertain, economic implications for both debt and equity markets.  In particular, they examine the impact of the decision on the rate of interest charged by unsecured creditors.

The authors conclude that there is a fundamental conflict between the conceptual consistency and fairness established by Sons of Gwalia, and the efficiency of the insolvency regime.  The authors express their doubt whether any legislative regime can fix this conflict.  Rather, they argue that the law should subordinate debts owed to shareholders on account of the irreconcilability with an efficient insolvency regime.

(Note - see the April 2007 issue of BLU for another article ("Sons of Gwalia: Navigating the line between membership and creditor rights in corporate insolvencies") that discusses Sons of Gwalia and the competing considerations in relation to shareholder subordination).

 

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