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LATEST ROUND OF PROPOSED CHANGES TO THE FMCA RINGS SOME WARNING BELLS FOR DIMS PROVIDERS
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Cabinet has finally approved a further round of decisions on the regulation of discretionary investment management services. It’s been a roller coaster ride for this widely misunderstood category of financial adviser services. This Financial Law Insight considers the impact of the latest round of proposed changes, and rings some warning bells.

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What’s the fuss about?

In recent months a growing level of concern has been raised over the absence of any transitional relief for current DIMS providers to accommodate the extensive changes required under the Financial Markets Conduct Act 2013 (‘FMCA’) and related Financial Advisers Act 2008 (‘FAA’) reforms. These concerns were highlighted in our April Financial Law Insight and our related seminars. The fact that many of the detailed requirements had yet to be promulgated less than six months out from the scheduled implementation date placed many providers in an impossible position. 

To its credit, the Ministry of Business, Innovation and Employment responded proactively to these concerns. Targeted consultation occurred on the issues identified, and that process has resulted in a series of Cabinet decisions on 16 June 2014. These Cabinet decisions have been swiftly followed up by FMA releasing a ‘Quick guide to licence applications for small businesses providing DIMS’ – supporting ‘DIMS-lite’ applications. 

DIMS under the FMCA reforms – recap 

The FMCA reforms largely turn the current model for providing DIMS on its head. 

Currently we have a very wide concept of what sorts of DIMS offerings will constitute a personalised service under the FAA. Only an individual can provide personalised services for retail clients under the FAA —and where the investment products accessed under the DIMS include the more complex, category 1 product-types, generally only an authorised financial adviser can provide that service (with a limited exception for QFE advisers). 

Any registered person (whether individual or corporate) can provide a DIMS as a class service—that is, a service that doesn’t take into account the financial situation or any of the goals of any of the client investors. And any registered person can provide DIMS for wholesale clients. 

Under the FMCA reforms, only the final sentence in the previous paragraph will remain the case. Even then, the definition of who will be recognised as a wholesale client for DIMS in the FMCA world is changing. 

Instead, class DIMS will be regulated exclusively under the FMCA. Only holders of a DIMS market services licence will be allowed to provide such a service, with DIMS licensees also allowed to provide personalised DIMS, subject to their licence terms. 

Under the FAA, only AFAs will be permitted to operate in the DIMS space, regardless of the types of investment accessed through the DIMS. And they will only be able to do so if their authorisation extends to the very narrowly defined concept of a personalised DIMS. If they stray outside of that concept for any of their retail clients, they will need a separate DIMS licence. 

FMA’s first published DIMS licence application guide made it very clear that very high capability, structural,  and resourcing expectations would need to be satisfied before a DIMS licence would be issued. All DIMS will need to be supported by new forms of client agreements and investment authorities with prescribed content requirements. Further detail on all of these concepts and the way they will operate under the FMCA reforms—and more —can be found in our April Financial Law Insight

In short, the combination of the extreme restrictions on the level of DIMS that will count as personalised DIMS and available to AFAs to provide, and the high hurdle posed by DIMS licensing under the FMCA, had many AFAs and the entities they represent crying foul. For many, the only viable option appeared to be to exit this space, threatening client relationships. 

The Cabinet decisions

The Commerce Minister announced the Cabinet decisions made on 16 June at a Financial Markets Law conference chaired by our own David Ireland. These decisions fall into two categories. 

Scope relief

The Cabinet decisions recognise a range of participants involved in DIMS or DIMS-like activity:

  • Contingency DIMS: AFAs providing DIMS only in limited circumstances, such as when clients are on holiday. 
  • Personalised DIMS: AFAs who believe their service will be able to meet the newly defined concept of personalised DIMS under FAA. 
  • AFAs providing simple DIMS: These AFAs exercise very little discretion themselves and typically don’t develop client investment portfolios themselves, but instead adopt model portfolios provided by reputable, independent research houses. The decisions they make on behalf of clients are largely limited to tracking those portfolios. It is this group who will benefit most from FMA’s new DIMS licence application guide. 
  • Corporate providers of DIMS: The ‘big boys’, being the more sophisticated providers confident they will have the wherewithal to obtain a DIMS licence under the existing rules and operate successfully under it. 
  • Rebalancing: AFAs who only provide DIMS as a rebalancing service, who can adjust their service model to a straight mechanical exercise involving no discretion (and therefore not constituting DIMS). 

Given this range of offerings, Cabinet has at last realised that this is not a space where a one-size-fits-all model can be applied, without inflicting undue costs and reducing choice for the retail clients the FMCA reforms were aimed at protecting. Measures have now been approved in principle to provide some balanced relief for two of the types of DIMS offering recognised: 

  • For contingency DIMS: AFAs will receive a limited exemption from the FMCA DIMS licensing regime where a DIMS is only provided as a temporary adjunct to the normal financial adviser service, and the client is informed of the limitations on the service. 
  • For simple DIMS: Cabinet has approved a reduction in the base licence application fee (from $3,565 down to $2,139), recognising that a DIMS-lite application will not take it as long to consider as a full corporate provider application. However, if the application takes FMA more than 15 hours to complete, applicants will pay a further $178.25 per hour to get it processed. In conjunction with this, Cabinet has endorsed FMA’s approach to issuing DIMS-lite application guidance, with the Minister of Commerce given power to make all decisions necessary to support a flexible approach to licensing DIMS businesses. 

By omission, those providing DIMS in circumstances outside the four categories of DIMS outlined above will be left to adjust their service models to fit within one of those categories if they are to continue with a DIMS once the reforms kick in. The alternative will be to move to a non-DIMS rebalancing model, and/or move out of implementing changes to clients’ investments without their input altogether. 

Transition relief

In addition to recognising that relief is required for the contingency DIMS and simple DIMS categories, Cabinet has also recognised that 1 December 2014 is just too soon for all this to come into effect. Accordingly, we are going to end up with a staged implementation of the new DIMS regime over the 12 months ending on 1 December 2015: 

  • Those who don’t commence business as a DIMS provider prior to 1 December 2014 get no relief. They will need to fully comply with the new regime from day one. 
  • Those lawfully providing DIMS prior to 1 December 2014 will be allowed to continue operating on the current basis up until 1 June 2015.
  • By 1 June 2015 existing DIMS providers who want to continue in the retail space will need to have either completed and submitted their DIMS licence applications, or have got themselves sorted to apply for authorisation to provide personalised DIMS and have their paperwork in order to support that. 
  • 1 June 2015 also marks the new date by which all DIMS providers will need to have an independent custodian in place, unless they have expressly sought relief from FMA to use a related party.
  • On 1 December 2015 this stay of execution comes to an end. By that date, anyone wishing to provide DIMS will need to either do so under a DIMS licence, or be an AFA providing a personalised DIMS with the terms of their authorisation reflecting that.

Practical considerations

We welcome the relief that has been provided. The extensive transitional period in particular is a necessity if the new regime is to be implemented with any coherency. 

The contingency DIMS exemption looks like a well-balanced solution to the old incidental service chestnut. It will be fascinating to see how the concept of a ‘temporary adjunct’ to a normal financial adviser service will be defined in regulations. Our concern here is that a fear of AFAs abusing this relief may unduly straight-jacket the circumstances in which the relief is made available, undermining its efficacy. Let’s hope not. 

An interesting twist on this relief is that only AFAs stand to benefit. Others—such as lawyers and accountants—are not able to take advantage of it. And lawyers and accountants do not have the same relief from the FMCA that they enjoy from the FAA. Accordingly, non-AFAs acting under client powers of attorney in the course of their business are not out of the woods yet. Whether there will be any scope for them to access the contingency DIMS relief remains to be seen, but is unlikely. 

Whilst the Cabinet has recognised a ‘rebalancing’ category of DIMS-like activity, no actual relief has been given or proposed in relation to just how ‘mechanical’ the rebalancing exercise needs to be in order to escape the DIMS net. 

We feel this lack of flexibility in the rebalancing activity able to be undertaken by anyone other than a DIMS licensee or DIMS-authorised AFA is unfortunate, and may result in some clients receiving a less effective level of service than currently enjoyed. We would like to have seen some leeway given to enable some limited discretion for AFAs to swap like-for-like products when undertaking a rebalancing, without requiring them to go through the full DIMS process. 

The DIMS-lite licence application process is a pragmatic approach many AFAs will no doubt look to avail themselves of. It’s unfortunate that this flexible approach has only come out now. Many businesses have already invested heavily—both financially and emotionally—in developing business models to respond to the regime first offered to them, and will now have to revisit their thinking. 

Better late than never? Undoubtedly, but it is important that AFAs don’t knee-jerk to this latest development. Becoming a DIMS licensee is still a significant business decision, with a number of hidden and not-so-hidden costs and challenges involved. Whilst the application process might be cheaper and simpler, FMA is unlikely to relax its high expectations of this sector—and nor should it.

The June Cabinet paper already contemplates providing further relief in respect of one particular consequence of becoming a DIMS licensee.  That relates to the fact that holders of market services licences become FMC reporting entities for financial reporting purposes. Amongst other things, this requires audited financial statements to be completed, which then need to be publicly filed with the provider’s records. It seems FMA is already considering whether an exemption from these requirements will be justified for some DIMS providers, where the business is relatively small and the statements may have limited benefit. Such relief already comes within FMA’s exemption making powers. 

Another area where the consequences of becoming a DIMS licensee (or even becoming authorised to provide personalised DIMS as an AFA) are unclear is in relation to the levy implications. It has already been signalled that the FMA levy regime is up for review in the second half of the year to accommodate the FMCA reforms. Our expectation is that this review will result in those providing DIMS under a DIMS licence being grouped in the same category as managers of managed investment schemes. The levies involved there are generally measured in the tens of thousands p.a., in addition to all of their other   regulatory costs. 

Conclusion

The levy imposition issue is just one of the jokers in the pack for DIMS providers to be wary of. The heightened level of regulatory oversight that is likely to come with those obtaining a DIMS licence, or even those becoming authorised to provide personalised DIMS as an AFA, will inevitably result in more management time being absorbed through regulatory compliance matters. Providers will need to weigh up whether the benefits of remaining in this space outweigh those costs of being involved. Whilst Cabinet decisions have been made, the detail has yet to be promulgated, and there are still questions left to be answered. Our advice for now is to proceed with caution. 

Start a conversation… 

If you would like a briefing on the operation of DIMS under the FMCA reforms, advice on transition options, or help with any other issue, contact David Ireland on +64 4 498 0840, Catriona Grover on +64 4 498 0816, or Nick Summerfield on +64 4 498 0876, or email the team at financialmarkets@kensingtonswan.com.

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