Key John: Public Finance (State Sector Management) Bill — Second Reading Instruction to Committee In Committee 
Text is incorporated into the Bound Volume 
Key John: Public Finance (State Sector Management) Bill — Second Reading Instruction to Committee In Committee 
[Sitting date: 14 December 2004. Volume:622;Page:17867. Text is incorporated into the Bound Volume.] 
JOHN KEY (National—Helensville) 
: 
 I want to respond to the amendments proposed by the Green Party in relation to derivatives and to make some comments around those because the Finance and Expenditure Committee received quite a number of submissions on them led mainly by Sue Newberry and Alan Robb I think of the University of Canterbury. I did not agree with their submissions at all. They were based on the fact that they believe that under section 55 of the Public Finance Act—which makes the New Zealand public unlimited guarantors of all public debt—derivative transactions entered into by the Crown would effectively be guaranteed by the taxpayer of New Zealand. In one sense that is correct. But—and I think this is the “but” people have to consider before they get too extreme—we need to look at what might be happening in the State sector in relation to derivatives and at who is actually using them. My understanding and the understanding of the select committee is that derivatives are being employed by the Debt Management Office. The derivatives are fundamentally interest rate derivatives. Basically the office is looking to swap its exposure from fixed to floating and from floating to fixed. There is some limited use of credit derivatives although I am not sure it has progressed to the latter. 
Essentially for all intents and purposes the first thing the Committee needs to consider is the liability around when the Crown actually purchases derivatives and when it sells them. When it purchases derivatives it is like purchasing insurance. It has a liability totally quantified by the premium under which it pays and therefore the Committee should not feel at all concerned about that. Where the Crown writes derivatives that can pose a liability. We have seen examples of where fraudulent activity takes place and Nick Leeson is a great example of that in Barings Bank. But I think there are quite a number of safeguards. 
We questioned the select committee about the process under which the review of derivative transactions was taken within the Debt Management Office and the segregation and separation of who was able to undertake those transactions. I think it was quite clear to the committee that there was a rigorous process in place in respect of derivative transactions where they were transparent where they were mark-to-market where they were consistent with the size of the portfolio where they were very vanilla derivative transactions and where they were not of the nature to which Sue Newberry and I think her fellow submitters wanted to claim that the Crown was exposed. 
It is also worth recognising—because one or two others internationally have also made statements around that sort of Armageddon scenario in derivatives—that derivatives can reduce risk and exposure for the Crown quite significantly. It all comes down to the people who are undertaking them and to the rights and responsibilities they have in the process for managing that risk. At this stage unless some select committee has been misled—and I have no reason to believe that one has—then I do not think there is a risk to the Crown and it should be able to continue to use those. Where other Government departments or parts of the State sector wish to undertake derivative transactions then first there would have to be some very solid reasons for doing that. It would be unlikely that most Government departments would although some actually can manage their own foreign exchange exposure and on that basis they could have currency derivatives. Again as long as those are handled in the right way with the right process and the right procedures then I do not think that is something for alarm and concern. 
The amendment put forward by the Greens to section 27(2)(b) really just says that a statement of all securities derivative transactions investments and guarantees should be listed. In one sense that is a fairly benign statement. I would not argue that the world would cave in because we had that in the legislation but my understanding is that that would be exactly the risk a committee would be looking at and reviewing. As long as the risk committees of those various departments of Government are doing their jobs properly and are in fact looking at those I cannot see why we need to insert that physically into the legislation. 
So I do not agree with the position taken by the Greens. I certainly do not agree with the position taken by Sue Newberry and I do not think we should have any degree of alarm. My involvement with the Debt Management Office in a professional sense goes back for the last 20 years and in my opinion it acts extremely professionally in the marketplace and does a very good job of managing New Zealand’s debt. We should in fact be quite proud of what it does.