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:
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:
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.