Taming the wild beast: the regulation of equity derivatives in New Zealand
The causes of the recent global financial crisis (GFC) have been the topic of intense debate; the contribution of the enormous growth in, and lack of regulation of, derivative financial products, including over-the-counter swaps has been one of the epicentres of that debate. The regulation of derivatives was a topic of some controversy internationally prior to the GFC; derivatives were sometimes referred to as the "wild beasts" of finance markets and some commentators highlighted the systemic risks posed to national economies due to the lack of regulation of these markets. In New Zealand the issue of the regulation of the disclosure of interests in equity securities related to swap agreements was raised in the case of Ithaca (Custodians) Ltd v Perry Corporation,  1 NZLR 731 (Ithaca), initially in 2002. The Court of Appeal decision in 2004 paved the way for the use of equity swap agreements without compliance with the substantial shareholder regime disclosure requirements found in the Securities Markets Act 1988 (NZ) (SMA). In the wake of the decision the news media reported that lawyers, brokers and investment bankers were of the view that the case had identified a "loophole" in the law that would enable their clients to avoid compliance with the substantial security holder disclosure provisions Some commentators argued that the case revived the image of New Zealand's markets as a 'wild west', an image that the substantial security holder disclosure regime and other regulatory reforms were designed to displace.
In response to the Court of Appeal decision in Ithaca the legislature drafted an amendment to the SMA that was intended to close the 'loophole'. However, during the legislative process the amendment was deleted, ironically in light of the media reports and subsequent global events, on the basis that the fact scenario in Ithaca was 'fact-specific to that case'. The result is that non-disclosure of interests in securities resulting from cash-settled equity swaps is currently sanctioned in New Zealand by both the Court of Appeal and Parliament.
This paper starts by discussing the substantial shareholder regime in New Zealand, including recent amendments, about which there has been little commentary. It then considers the development of derivatives, placing the Ithaca case and fact scenario, and recent international reform, in context. It analyses the Ithaca case in this international context, arguing that the fact scenario not only demonstrates that New Zealand markets reflect international trends, but also raises the same issues, and presents the same concerns, driving legislative reform in the US, the UK and Australia. It argues that New Zealand's failure to respond to those issues and concerns places it out of step with best practice internationally, and with international responses to the GFC; it is time to tame the wild beast in the wild wes.
The reference to derivatives as a wild beast is taken from Alfred Steinherr, Derivatives: the Wild Beast of Finance (Chichester: Wiley, 2000).