Disclosure regimes are notoriously difficult to get right, reflecting the inherent tensions among their various objectives – tailoring and comparability, brevity and materiality.
Indeed, disclosure as a basis for securities regulation is under challenge on a number of fronts: at a theoretical level as a result of insights from behavioural economics, at a practical level from evidence that retail investors are turned off by long and complex offer documentation and at a regulatory design level with the growth of alternative consumer and market integrity frameworks.
The Financial System Inquiry is wrestling with these issues in Australia now. New Zealand has recently revitalised its disclosure regime in the context of the Financial Markets Conduct Act (FMCA), the relevant provisions of which will come into effect on 1 December.
In the early stages of the New Zealand reform process, the temptation was to go for radical ‘quick fix’ solutions, such as two-page disclosure documents. But it was recognised that while this would solve the length issue, it would do nothing to address the information asymmetry that lies at the core of all mandatory disclosure requirements or to enable investors to make informed choices between different options.
As the disclosure problem is a complex and multi-dimensional one, so too was the required solution.
The most significant change from the Securities Act is the revisiting of the idea that the offer document for all financial products should be essentially the same in structure and content, in order to facilitate comparison. Instead the policy design for the FMCA recognises specific guiding principles for each of the four financial product categories provided for in the Act:
- equities - to enable investors to assess the underlying business, including the current value of assets, growth prospects and how the capital raised will be used
- debt - to enable investors to assess the likelihood of the issuer repaying its obligations under the debt security based on the creditworthiness of the borrower, the business of the issuer, the nature of the securities and the purpose for raising the money
- managed investment schemes – for managed funds, assisting investors to understand the scheme’s investment objectives (particularly the risk and return trade-offs) and fees; for ‘other’ managed investment schemes, ensuring the investor understands the assets underlying the scheme
- derivatives - to enable customers to assess how the derivatives function and the risks associated with them.
These guiding principles are reflected in the Product Disclosure Statement (PDS) requirements in the draft FMC Regulations. The PDS for equity can be relatively long by FMCA standards (although, at a maximum 60 pages, still a fraction of the length of most equity IPO prospectuses produced under the Securities Act) and has much more flexibility as to content.
The managed funds PDS, by contrast, is subject to heavy prescription and tight page limits but will be buttressed by the publication of mandatory quarterly fund updates.
Comparability under the FMCA is achieved primarily through the Key Information Summary (KIS) that is required to be included in each PDS and through the electronic offer register.
The requirements for the KIS are particular to each financial product type and are intended to ensure that the most important information to investors is provided up front. For example, the KIS for equity securities is required to give the “key drivers” and “key risks” of the investment. Similarly, the debt KIS must include a credit rating chart (if the issuer is rated), showing not just the credit rating but where this fits on the relevant rating scale.
Importantly, regulation 18 of the draft FMC Regulations recognises the subjective judgement that will be required of directors in setting out the factors that in their opinion most significantly affect financial performance or that are the key risks of the business. Regulation 18 provides in relation to all financial products:
The purpose of a KIS is to provide the issuer’s assessment of the most significant aspects of the offer of the financial products that are relevant to a prudent but non-expert person’s decision as to whether or not to acquire the financial products. (Emphasis added.)
Clear, concise and effective
The desire for briefer offer documents has led to hard page limits (excluding cover and application forms) being adopted in the draft FMC Regulations.
- Equity: 60 A4 pages or 36,000 words, sublimit of 4 pages/2,400 words for the KIS.
- Debt and derivatives: 30 A4 pages or 18,000 words with a KIS sublimit for debt offerings of 3 pages/1,800 words.
- Managed Investment Schemes: 12 A4 pages or 7,200 words for managed fund products, otherwise as for equity securities.
The regulator – the Financial Markets Authority (FMA) - has characterised the need for these rules as a “circuit breaker” for issuers and their advisers to break out of "kitchen sink" disclosure practices.
To assist issuers in achieving these page limits, the PDS is arranged in a far more logical manner than the Q&A straightjacket of the current investment statement, reducing the scope for the repetition.
Another feature of the FMC Regulations is the increased use of tables, diagrams and charts, which has also been encouraged by the FMA. Among the most notable in this regard are the risk indicators for managed investment products and the comparable pricing graph and ranking table required for debt securities.
The key question of ‘material information’
A key and welcome innovation of the FMCA in relation to its predecessor legislation is that it defines “material information”:
In this Part, material information, in relation to a regulated offer, means information that—
(a) a reasonable person would expect to, or to be likely to, influence persons who commonly invest in financial products in deciding whether to acquire the financial products on offer; and
(b) relates to the particular financial products on offer or the particular issuer, rather than to financial products generally or issuers generally.
This builds on the established common law but is enhanced through the explicit connection to rational market factors, that will allow assessments to be made as much as is possible on an objective basis. It also serves to clarify that disclosures are issuer-specific, reducing the tendency for “me too” risk factors and other boilerplate.
The new electronic offer register
The offer register will replace the prospectus but, until there is an emergence of practice in relation to full FMCA offers, the issue of how much continuity there will be between the two forms and how much difference is not capable of a full answer.
Fears are that it will become a dumping ground by fearful issuers and their advisors for anything which could be remotely conceived as material or – in the alternative – that the information on the register will be insufficiently scrutinised or organised, exposing directors and other market participants to liability for defective disclosure.
From experiences elsewhere and from the draft FMC Regulations, it is clear that two sorts of registration requirements are contemplated - specific documents (or information that would likely be presented in the form of a document) and data required to be inputted into designated fields, to enable the register’s ‘google’ functionality.
The PDS system also relies heavily on ‘incorporation by reference’, with such things as financial statements, material contracts or descriptions of them, and independent expert reports contained on the offer register.