Crown Guarantee Scheme - an overview

In response to similar initiatives abroad, the New Zealand Government announced a retail deposit guarantee scheme on 12 October. A further announcement of a wholesale funding guarantee facility followed on 1 November. The scheme has evolved over the past month but now appears to be mostly settled.

RETAIL SCHEME

The scheme was announced by Dr Michael Cullen in his previous role as Minister of Finance in order to ensure ongoing depositor confidence in New Zealand and to align the New Zealand market with the rest of the world. Failure to act is likely to have resulted in the migration of deposits from New Zealand banks to guaranteed banks offshore.

What is the scheme?

• The scheme guarantees deposits made by retail investors with certain types of financial institutions. Those institutions are:

• registered banks (whether incorporated in New Zealand or overseas);

• non-bank deposit takers; and

• certain types of collective investments schemes (essentially unit trusts and managed funds).

• It is a guarantee of principal and interest and applies to all deposits except:

• deposits made by financial institutions themselves; and

• deposits made by parties related to the guaranteed institution.

• The guarantee covers a guaranteed financial institution that goes into default between 12 October 2008 and 12 October 2010.

• There are provisions enabling the Crown to revoke the guarantee if the relevant guaranteed institution fails to:

• comply with prudential supervision requirements or their trust deed; or

• provide information requested by the Crown or if any information provided is not accurate.

How are the eligible institutions defined?

• A registered bank includes any bank incorporated in New Zealand, and unincorporated branches of overseas banks. Some limits will apply to unincorporated branches of overseas banks – see below.

• A non-bank deposit taker is an entity that:

• carries on the business of borrowing and lending, or provides financial services, or both;

• issues debt securities; and

• predominantly carries on its business in New Zealand.

• A collective investment scheme must invest exclusively in New Zealand government securities and in debt securities issued by institutions that are covered by the Crown guarantee. These schemes will have their deposits in the guaranteed institution specifically guaranteed rather than enjoying the benefit of the guarantee themselves.

Who will be guaranteed?

• It is expected that all institutions that are eligible for the scheme will apply to be covered by the guarantee. Those institutions are required to opt-in to the scheme and individual depositors will be able to check the Treasury's website to determine if the institutions with which they have deposits are part of the scheme.

• The Treasury has the ultimate discretion in deciding whether or not to extend the guarantee to an institution and may consider whether:

• the business practices of the applicant meet reasonable standards;

• the individuals that control the applicant are of good character and have appropriate business experience; and

• the applicant has been in business long enough to justify its coverage by the guarantee.

• Further to the requirements above, a guaranteed non-bank deposit taker and a collective investment scheme subject to the guarantee will have to meet ongoing obligations that include:

• limitations on transactions with related companies and issuing dividends;

• requiring business to be conducted in a proper, businesslike, efficient and prudent manner;

• allowing the Crown to appoint an inspector; and

• imposing direct obligations on directors in relation to compliance with the company's trust deed and an increase in reporting requirements.

How much will be guaranteed?

• The scheme has been capped at a guarantee of $1 million per depositor, per institution.

• There is no upper limit to which the overall scheme can be applied. This is qualified by a limitation on deposits held by branches of overseas banks. Those institutions are only guaranteed to the total amount that was on their books on the day the scheme was announced, with a small allowance for growth.

• Money held in a joint account will be split into equal shares to be attributed to each individual depositor.

• The scheme will look through a bare trustee and apply the cap to each individual beneficiary of a bare trust. A similar look-through will apply to collective investment schemes.

Will a fee be charged?

• Individuals will not be charged any direct fee in order to benefit from the scheme.

• For institutions that hold deposits over $5 billion, a fee of 10 basis points per annum will be charged on those deposits that exceed $5 billion.

• Institutions that hold deposits under $5 billion will be charged a fee on the cumulative growth of their book value from the day the scheme was announced that is over and above the permitted growth of 10%. This fee will be charged on a graduated basis determined by the credit rating of the institution, as set out below:

Credit Rating	Fee (bps per annum)
AA- and above	10
A- to A+	20
BBB- to BBB+	50
BB and BB+	100
below BB and unrated	300

 

WHOLESALE SCHEME

The Government has also offered a wholesale funding guarantee facility to investment grade financial institutions that have substantial borrowing and lending operations in New Zealand.

Who will be guaranteed under the facility?

• The facility will be available to financial institutions that have a rating of BBB- or better. Eligible institutions are required to opt in and will also be expected to have opted in to the retail scheme where relevant.

• New Zealand branches of overseas banks are eligible, but only in respect of issues of New Zealand dollar instruments.

• The facility is not available to institutions that are financing a parent or related company, non-financial issuers (for example, corporate or local authority issuers) and collective investment schemes.

• Institutions that obtain the benefit of the guarantee will have to fulfil ongoing obligations, including:

• additional capital buffers;

• prudential supervision for registered banks;

• non-bank institutions will be subject to additional information requirements; and

• an undertaking that the foreign exchange risk associated with foreign currency borrowing will be hedged and managed.

What will be guaranteed?

• All new issues of senior unsecured negotiable or transferable debt securities in all major currencies are eligible. Covered bonds are also eligible. Other asset-backed securities and subordinated debt issues are not eligible.

• Participating institutions must apply for an eligible instrument to be covered. The facility operates on an opt-in basis for each eligible instrument rather than on the basis of automatic coverage for all eligible instruments of a participating institution.

What is the fee that will be charged?

• The fee will be charged on a 'per guaranteed instrument' basis. It is designed to ensure that the facility is used while it is needed, but will encourage issuers to graduate from using the guarantee as market conditions permit.

• The fee will be based on the credit rating of the issuer and the terms of the instrument guaranteed, as set out below:

	Fee (bps per annum)
Credit Rating of issuer	1 year term or less	1+ year term
AA- and above	85	140
A- to A+	145	200
BBB- to BBB+	195	250

As mentioned above, the Treasury has the discretion to decide whether or not to grant the guarantee to an institution, whether retail or wholesale. The powers of the Treasury are designed to ensure regulators can eliminate any artificial applications. Provided that this discretion is exercised in a consistent and transparent way, especially with regard to the retail scheme, it can only benefit existing market participants by removing the potential for gaming of the scheme and the further distortion of the market that would follow.

The Treasury is in the process of approving registered banks and has begun approving non-bank deposit takers. Currently, 11 registered banks and 28 non-bank deposit takers have been approved. Approvals for collective investment schemes and wholesale guarantees are expected to follow.

For further information please contact:

Murray King
Partner

David McPherson
Partner

David Craig
Partner

Hugh Kettle
Partner

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.