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ANOTHER ROUND OF FINANCIAL ADVISER REFORMS ARE ON THE WAY
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The much anticipated Ministry report on the review of the Financial Advisers Act was released to the public on 13 July. The outcome? The current regime for delivering financial advice is broken. The Ministry’s response: Can we fix it? Yes we can!

In Brief

Looking back

  • Current regime is not fit for purpose
  • Accessibility of appropriate advice and complexity are major problems
  • Compliance requirements are unduly burdensome and poorly targeted
  • Code of Professional Conduct for AFAs and Code Committee are working well
  • Regulation of brokers and custodians and the dispute resolution regime are also working well and unlikely to change

Looking forward

  • ‘Consumer first’ and base competency for all to be legislated
  • Code of conduct to apply to all financial advice scenarios
  • Regime to be simplified
  • No ban on commissions
  • New designations of financial adviser and agent, removal of individual authorisation
  • Licensing for all financial advice firms to support robo-advice and ensure firms are accountable for agents’ advic

The review of the Financial Advisers and Financial Service Providers legislation kicked off in late 2014. Since then, the Ministry of Business, Innovation and Employment (MBIE) has undertaken an exhaustive consultation process, including an issues paper and an options paper released along the way. This culminated in a comprehensive report setting out the good, the bad, and the ugly of the current regime, and MBIE’s recommendations for the future.

The review and MBIE’s recommendations to the Minister of Commerce and Consumer Affairs comprised two parts–the review of the Financial Advisers Act 2008 and a narrower scope of work involving the review of the Financial Service Providers (Registration and Dispute Resolution) Act 2008. This Financial Law Insight focuses on the Financial Advisers Act review.  We will comment on the Financial Service Providers registration rules review outcome in a separate Financial Law Insight.

So what’s the problem?

The current regime regulating financial advisers and the provision of financial advice is not fit for purpose. That conclusion will come as no surprise to those who participated in the consultation process, but with the current regime only coming into force less than six years ago, the outcome may be a surprise in some quarters.

The major issues identified in MBIE’s report are:

  • Some types of financial advice are not being provided:
    • The current regime does not support technological innovation, such as robo-advice
    • Limited personalised advice is not being provided due to regulatory boundaries which create perverse incentives for providers to limit services to class advice. Those with simpler needs or smaller amounts to invest are not able to access the financial advice they require: there is an ‘advice-gap’.
  • The quality of financial advice provided may be sub-optimal:
    • Disproportionate competency requirements create the risk of a varied quality of advice, with only the relatively small population of authorised financial advisers (AFAs) required to meet minimum standards of competence, knowledge and skills
    • This is compounded by the current category 1 versus category 2 product distinction not reflecting risk or complexity. This means some financial advisers are allowed to deliver complex and/or high risk financial advice without having to meet any standard of competency to do so
    • The majority of advisers are not required to put consumers’ interests first, with only AFAs obliged to do so (although some registered financial advisers voluntarily adopt that ethical standard from the AFA Code of Professional Conduct)
    • Conflicts of interest may compromise advice, resulting in poor outcomes for consumers, although MBIE acknowledged that it is difficult to gauge the full extent of poor advice
    • The current disclosure obligations of conflicted remuneration for financial advisers is inadequate
    • Different registration, licensing and reporting requirements create inconsistencies. The definition of financial advice does not always capture the activities that should be regulated.
  • Compliance costs are disproportionate:
    • Compliance costs and regulatory requirements not only form barriers to entry, but prevent more established advisers from remaining viable and competitive, forcing them to be selective about their clientele and scopes of service.  Some of the required compliance activities have limited benefit for consumers and those who provide financial advice.
  • Unnecessary complexity is preventing adequate consumer protection and understanding:
    • Some terminology is confusing and misleading to consumers, making it difficult for them to understand and respond appropriately
    • Current disclosure and client care obligations are inconsistent and of limited use to consumers, which results in consumers struggling to find quality financial advice.

That’s a fairly damning summary of the unintended consequences of the current regime that was heralded in with much fanfare back in 2010. However, it’s not all bad news. Some significant gains have been made, as outlined in the following section.

What’s good about the current regime?

The report identifies the current regulation of brokers and custodians as effective, with no proposals for change. Kensington Swan’s view is that the regulation of broking services and custodians sits very uneasily in an Act that purportedly focuses on financial advisers. It would sit far more logically within the Financial Markets Conduct Act 2013. Wherever the rules sit, it seems that there will be little change in this area. That means the confusion over the use of the unfortunate legislated descriptor ‘broker’ is set to remain.

The dispute resolution regime has also been identified as functioning well, overall, with no proposal to rationalise the number of dispute resolution providers through legislative means.

We were pleased to see the Minister’s strong endorsement of the work of the Code Committee charged with developing and maintaining the Code of Professional Conduct for AFAs, with Kensington Swan partner David Ireland having chaired that Committee for the past four years.

The Minister noted that ‘the Code Committee for Financial Advisers and the process it follows in preparing and reviewing the Code of Professional Conduct is transparent, collaborative and working well’, and one of the strengths of the current regime. This endorsement was fleshed out in MBIE’s comprehensive final report, as well as by a number of contributors to the MBIE papers. This is reflected in the recommended changes, with a single code of conduct proposed to govern all financial advice.

The QFE model was also noted as a strength of the current regime. Amongst other things, it supports flexibility in compliance and operating models. The proposed new regime goes one step further and has the concept of universal licensing of financial advice firms at its core.

What are the recommended changes?

The key changes that we are likely to see in a new ‘Financial Advice Act’ are:

  • A simplification of the regime for delivering financial advice by removing unnecessary complexity and regulatory boundaries:
    • The concept of class versus personalised advice and category 1 versus category 2 products will be gone. Also gone will be the requirement for a ‘natural person’ to provide personalised advice. This will support the provision of robo-advice and make it easier to tailor financial advice to the consumer’s needs.
  • An even playing field will be established with more proportionate regulatory requirements:
    • All individuals and robo-advice platforms providing financial advice will be required to place the interests of the consumer first, and provide advice only where competent to do so – a current feature at the heart of the AFA Code of Professional Conduct. All financial advice will be subject to a universal code of conduct, with standards being set within that code that are likely to vary for different types of advice.
  • Current adviser designations to be scrapped:
    • Gone will be the concept of authorised financial advisers (AFA), registered financial advisers (RFA) and qualifying financial entity (QFE) advisers. Instead, anyone providing financial advice will either be a ‘financial adviser’ or ‘agent’ of a financial advice firm. Financial advisers will be individually accountable for complying with their legislative and Code obligations. ‘Financial adviser’ will become a restricted term, in similar fashion to the current restriction on holding yourself out as a financial or investment planner.
  • Consumer understanding will be improved through more effective disclosure and client care requirements:
    • More meaningful disclosure requirements will be introduced. There may be a degree of scepticism about this particular recommendation, given that the existing regime does not inhibit the development of meaningful disclosure requirements. Hopefully it will work this time.
    • Of significance is the introduction of a client-care obligation applying to all financial advisers and agents to ensure that consumers are aware of any limitations in the advice being provided (although the meaning of ‘limitations’ in this context will inevitably be a bone of contention).
  • Low cost, fit for purpose, licensing will be introduced:
    • All financial advice firms will need to be licensed, removing the licensing burden at the individual level. This is intended to replicate the efficiencies of the current QFE model. The licensing of firms is intended to be  flexible, depending on the size and nature of the firm, and FMA will be responsible for that licensing process. A clear challenge for FMA will be how to strike the right balance in operating a flexible, proportionate licensing regime.
  • No ban or restriction on commissions:
    • The Minister does not favour banning or restricting commissions, due to the risk of further limiting advice, and the fact that doing so is unlikely to address all conflicts of interest: ‘Banning commissions is not a ‘silver bullet’ that will improve the quality of advice’ (MBIE’s Factsheet). Instead, conflict of interest issues will be addressed through other means.

Kensington Swan’s take

We strongly support the proposed reshaping of the regulatory environment governing the delivery of financial advice. The transparent, comprehensive and consultative process MBIE has followed in developing the final report to the Minister is an exemplar of how regulatory reform processes should operate. MBIE’s hard-working team is to be commended for the way they have gone about their business.

Inevitably, there will be many devils in the detail of the new regime, but the proposed regulatory parameters within which those details will be developed are sound.

Yes, there will be challenges involved for participants in the sector, as we face yet another round of regulatory change. The prospect of wholesale licensing for all financial advice firms will cause trepidation for some. The way MBIE frames up the licensing parameters, and the manner in which FMA goes about the licensing process, will determine whether the new regime (and the transition to it), is a success or a failure. One thing is for sure, we don’t want to be back here in five years’ time looking at another comprehensive review of the regime.

One ugly aspect of the proposals is the creation of the new term ‘agent’ to describe an individual for whose advice a licensed financial advice firm will be accountable. It seems that the lessons of the unfortunate statutory term ‘broker’ that was included in the current regime have not been learned.

The concept of ‘agent’, as set out in MBIE’s proposals, does not match the way the term is widely used in practice, or its legal definition. Agents under the new regime will not necessarily be agents for other purposes. Indeed many will be subject to terms of engagement with their financial advice firm that expressly state that their relationship is not one of principal-agent and they are not to hold themselves out as agents. Tricky…

In addition, the category of individuals who are able to call themselves ‘financial advisers’ may also be ‘agents’ by virtue of their relationship with their financial advice firm. This has the potential to create new areas of confusion for consumers and participants alike, although that confusion is unlikely to be as extreme as the confusion caused by the current legislative terminology.

Just where those whose financial advice is limited to wholesale clients fit in the regime, and who will be exempt from the financial advice firm licensing requirements, is unclear. We understand that current exemption and wholesale client relief settings will remain, but those on the boundaries will need to pay careful attention to the details as they unfold.

What is also unclear from MBIE’s report is how to deal with the challenges of the provision of discretionary investment management services (DIMS). Currently DIMS is covered by the Financial Advisers Act, although only to a very limited extent, with a comprehensive regime for the licensing of DIMS now provided under the Financial Markets Conduct Act. This aspect will be of particular interest to the handful of AFAs who have been authorised to provide personalised DIMS. Our view is that this form of service fits more comfortably within the Financial Markets Conduct Act, but we will need to wait to see how the regulation of this type of financial adviser service unfolds.

Where to next?

The Minister of Commerce and Consumer Affairs, Paul Goldsmith, has stated that he would like to see legislation introduced into the House before the end of the year. He also stated that it is important not to rush things.

Introducing a first bill for this comprehensive change in the regulatory framework prior to the end of the year would indeed, in our opinion, be rushing it.

There is still much detail to be fleshed out in the proposals, not least the transition rules that will be key to managing the upheaval that will occur in implementing such a fundamental shift in the regulatory framework.

A further Cabinet paper is expected to be released in September regarding the transition arrangements. That Cabinet paper will also address the membership and proceedings of the Code Committee and the Financial Advisers Disciplinary Committee. We support this two-stage approach, which is a continuation of the measured approach that has been a feature of this reform process to date.

Regardless, it is absolutely critical that stakeholders have adequate opportunity to absorb the details of the proposals and provide meaningful feedback to ensure that the new regime is indeed fit for purpose and has sufficient flexibility to last the test of time.

With MBIE’s report being the result of a very well-considered and comprehensive stakeholder engagement and consultation process, it would be a shame if the final legislative outcome were then rushed through the Parliamentary process for the sake of political expediency. We understand the desirability of getting the regime fixed sooner rather than later, but we do see significant risk in the prospect of legislating in haste and then repenting at leisure.

The one constant for the financial advice sector this decade has been regulatory change, and that now looks set to continue through to 2018 at least. The constant change has impacted on the ability of financial advice firms to be able to get on with the actual business of delivering quality financial adviser services. That distraction is unfortunate collateral damage in the quest for a better regime. That message has been given to MBIE loud and clear. It is now up to the officials to minimise that burden on industry through an effective and proportionate set of transition rules.

Our take on the proposed reforms is that the pain is going to be worth it. MBIE’s final report and the Minister’s Cabinet paper provide good cause for optimism that the principles-based end result will be good for consumers and providers alike. Yes, there will be challenges to overcome–but also plenty of opportunities for those able to embrace the flexibility of the new regime.

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