In January 2016 Cygnus Law made submissions to MBIE proposing changes to law to address the problems presented by unsupervised NZ building societies.* The underlying issue is that loopholes in the Building Societies Act 1965 have been used to register closely-held building societies and to then use those building societies to operate overseas with little regulatory oversight in New Zealand. The latter issue arose in part because of the Reserve Bank’s decision to not supervise those building societies under non-bank deposit taker law (with the law later changed to remove such building societies from the definition of a non-bank deposit taker entirely). Interest.co.nz editor Gareth Vaughan has written extensively about such building societies.

What is a building society?

Building societies everywhere are intended to be (and are viewed as) conservatively run mutual organisations that take deposits and provide housing loans to members within their own countries (or specific regions within them).  Unsupervised NZ building societies can trade off that reputation even though they don’t have those characteristics.

Who would law reform affect?

Examples of two building societies that have utilised the loopholes are General Equity and Kiwi Deposit. In each case they met the requirement to have at least 20 members by incorporating 20 related shell companies to act as members. Ownership and control was effectively concentrated in the hands of very few people. A third building society, Safe & Sound, has a wider membership base but, like General Equity and Kiwi Deposit, appears to largely operate overseas. All of its directors are Australian and, while having a registered office in New Zealand, it appears to operate from a residential suburb in Brisbane.  There seems to be little, if any, benefit to New Zealand from enabling such building societies to operate.  Experience indicates that some create a real risk of causing significant damage to the reputation of New Zealand’s financial markets.

What are the issues?

General Equity illustrates the issues that can arise. It was the subject of a 2014 FMA warning (warning anyone dealing with General Equity to exercise extreme caution) and on 16 February 2016 it was deregistered from the Financial Service Providers Register (FSPR) at the direction of the FMA. The FMA can direct deregistration where an entity’s registration creates a false or misleading appearance of regulation in NZ or is otherwise damaging to the integrity or reputation of New Zealand’s financial markets. However, General Equity’s status as a building society in the circumstances is itself likely to create a misleading appearance of regulation in New Zealand.  Deregistration usually prevents an entity from continuing to provide financial services but General Equity’s website indicates it is still providing financial services. General Equity has continued to be in breach of law by failing to file financial statements and annual returns. Kiwi Deposit is in liquidation and at this stage it appears that creditors and shareholders will suffer significant losses.

Potential solutions

Cygnus Law’s submissions propose a number of fairly simple steps that could be taken to close those loopholes and to reduce the risks posed by such building societies. For example, by requiring that New Zealand building societies be restricted to providing services in New Zealand and/or by requiring that unsupervised building societies be converted into companies.

Law reform

These issues highlight a problem experienced by other special purpose entities that provide (or are able to provide) financial services and products, being friendly societies, credit unions and industrial & provident societies. They’re subject to out-dated legislation- the governing Act for industrial and provident societies is 116 years old.  While the law has been updated from time-to-time it is still not to a standard of modern legislation.  This creates the risk of the types of issues highlighted above.  Proposed reform was put on the back-burner in 2011 but there are current proposals to address some issues.  The submissions are seeking to introduce additional changes to law through that process.

Simon Papa

* Note: The submissions refer to the previous law under Part 5D of the Reserve Bank of New Zealand Act 1989. Part 5D was superseded by the Non-bank Deposit Takers Act 2013 in May 2014, which brought in a licensing regime.  However, this does not affect the issues raised or the proposed solutions in any material way.