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NEW LICENSING REQUIREMENTS UNDER THE FINANCIAL MARKETS CONDUCT ACT
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The Financial Markets Conduct Act 2013 will fundamentally change the laws that regulate securities offerings and capital markets in New Zealand. Much of the detail of the new regime will be prescribed by regulation and supported by regulatory guidance.

This Financial Law Insight provides a summary of the key features of the combined proposed licensing requirements put forward by the Ministry of Business, Innovation, and Employment and the Financial Markets Authority.

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Overview of the consultation

In early November 2013 the Ministry of Business, Innovation, and Employment released the first set of draft Regulations which will come into force at the same time as phase 1 of the Financial Markets Conduct Act 2013 on 1 April 2014. Shortly afterwards the Financial Markets Authority released consultation papers on its proposed minimum standards and conditions for new licenses.

The draft Regulations cover a number of areas, including some provisions that will not come into force until phase 2 of the Act commences on 1 December 2014. The key areas covered for phase 1 include:

  • transitional exemptions from the disclosure requirements of the Securities Act 1978, which apply as if they were exemptions from that Act
  • licensing and other regulation of market services, including requirements that apply to those providing crowd funding and peer-to-peer lending services.

Combined, these two sets of consultation documents give an indication of what the licensing regime under the Act should look like. Feedback is being sought on a number of provisions of the Regulations, as well as the proposed minimum licensing standards and conditions.

Licensing generally

Requirement to be licensed

A licence will generally be required before any person can:

  • act as a manager of a retail managed investment scheme (which include KiwiSaver schemes, superannuation schemes, and unit trusts)
  • act as an independent trustee of a restricted scheme (such as a workplace savings scheme)
  • provide discretionary investment management services (although authorised financial advisers can provide personalised discretionary investment management services, if within their scope of authorisation)
  • act as a derivatives issuer
  • provide a crowd funding or peer-to-peer lending service. 

This Financial Law Insight considers the first three types of licenses as well as general aspects of the proposed licensing regime.
 
FMA to issue licences

Applications for licences will be made to FMA. FMA may extend licences to apply to related entities of the principal applicant, provided certain conditions are met. These include a requirement that sufficient processes are in place for the principal applicant to maintain appropriate control or supervision over the provision of licensed services by the related entity.

FMA is required to have regard to certain principles when exercising its licensing powers, including that exercising the power (that is, granting a licence) is necessary or desirable to promote either or both of the main purposes of the Act. There is also a statutory requirement not to unnecessarily restrict licensing.

The second principle referred to above suggests there may be a presumption in favour of granting a licence where there is uncertainty. However, one of the main purposes of the Act is to promote the confident and informed participation of businesses, investors, and consumers in the financial markets. We think that in practice this objective will prevail, and that FMA is unlikely to grant a licence unless absolutely satisfied that the applicant will meet all of the criteria. In other words, any licensing condition that is seen as being necessary to support the main purposes of the Act will be regarded as a necessary restriction.

General licensing requirements

Under the Act, FMA must issue a licence if satisfied that:

  • any eligibility criteria prescribed by regulation (including those specifically for directors and senior managers) for the particular class of services are satisfied
  • the applicant is, or will be, registered on the Financial Service Providers Register to provide the service
  • the applicant's current and proposed directors and senior managers meet the ‘fit and proper’ test for their position
  • the applicant is capable of effectively performing the service (having regard to the proposed conditions of the licence)
  • there is no reason to believe that the applicant is likely to contravene its licensee obligations.

The draft Regulations propose that, among others, the following matters also apply to licences:

  • In determining whether an applicant is capable of performing the relevant services and whether there is any reason to believe the applicant is likely to contravene its licensee obligations, FMA must have regard to any relevant (in FMA’s opinion) convictions, orders, and successful disciplinary actions taken against a broadly defined class of ‘relevant parties’. This includes actions taken anywhere in the world.
  • When considering whether to authorise a related entity of the applicant under a licence, FMA must have regard to whether the executive directors and senior managers of that body corporate are fit and proper persons to hold their positions.
  • All licences are subject to a condition that the licensee or authorised bodies-corporate must report and provide all relevant information to FMA where the entity has reasonable grounds to believe that any of a broad class of events have occurred. These generally relate to the entity’s ability to perform the licensed service (and include, for example, an insolvency event or proceedings being brought against the licensee or its directors or senior management).
  • FMA may impose general conditions, including a requirement to hold minimum levels of professional indemnity insurance (and it is clear from the proposed minimum standards that this will inevitably be required). 

Managers of managed investment schemes

Licensing is required for all managers of ‘registered schemes’. This will include current schemes as well as closed products, even where there are no new investors as no new contributions are being accepted. This is because all existing schemes will automatically become ‘registered schemes’ under the Act at the end of the transition period.

The only specific requirement in the Act and proposed regulations for manager licences is that the manager’s constitution must not allow the directors to act otherwise than in the best interests of the manager. A similar (albeit more tightly defined) requirement applies to licensed issuers under the Insurance (Prudential Supervision) Act 2010. This requirement is not surprising, given the Act will impose best interests obligations on licensed managers.

As part of its minimum standards, FMA proposes minimum financial resources for licensed managers including:

  • a requirement to have positive net tangible assets (with related party receivables generally excluded)
  • a requirement to meet the solvency test
  • a need to have liquid assets sufficient to cover three months’ outgoings.

There is no absolute minimum level of capital currently proposed.

Licensees will need to consider carefully how they manage their financial resources requirements, particularly given our understanding that FMA will assess entities on a standalone basis. In other words, licensees will need to rely on their own balance sheets and may not be able to rely on parent company support, even if iron clad. We believe that taking such a strict approach would constitute an unnecessary restriction, and hope that in practice there will be sufficient flexibility to cater for legitimate corporate structuring.

FMA’s other proposed minimum standards for licensed managers are relatively non-controversial, and most managers should be comfortable with the requirements. However, they do appear to be drafted with large providers in mind, and boutique/smaller operators will need to consider how they would address these requirements. Those with any concerns should engage with FMA. 

DIMS providers

In similar fashion to licensed managers, DIMS licensees and any authorised bodies corporate cannot have in their constitution any provision under which directors of the entity may, when exercising powers or performing duties as a director, act otherwise than in the best interests of the applicant or authorised body corporate.

A key consideration for providers of discretionary investment management services is the extent to which their services will be covered by their DIMS licence. Unlike the definition of a DIMS under the Financial Advisers Act 2008, the Financial Markets Conduct Act definition expands the term to cover any financial advice provided in the ordinary course of, and incidentally to, providing a DIMS. That means a DIMS licensee won’t necessarily require the services of an authorised financial adviser when providing personalised financial advice about things like the appropriate scope of a client’s investment authority under the DIMS. Such advice will be covered by the DIMS licence, and exempt from the application of the Financial Advisers Act.

Recognising the scope for regulatory arbitrage this difference in defined terms creates, the DIMS licensing conditions proposed by FMA include requirements to ensure financial advice provided incidentally to providing a DIMS is provided with the same level of consumer protection as would have been the case had that advice been provided under the Financial Advisers Act. We support this approach in principle, but the tension between the two regimes and potential for unintended consequences is unfortunate.

DIMS providers will also be subject to conditions relating to disclosure to investors, agreement documentation, and record keeping. We consider the proposed conditions to be relatively non-controversial.

FMA may also allow DIMS providers to have client assets held by a related custodian, although it is clear that doing so would be subject to significant restrictions. In particular, the DIMS licensee will need to demonstrate the substantive independence of related custodians.

Those only providing DIMS at a wholesale level (such as institutional investment managers) enjoy a statutory exemption from the DIMS licensing requirement. Exemptions from DIMS licensing are also proposed to be prescribed for trustee corporations in relation to certain wills and estate management and administration services, as well as for statutory officers, Crown organisations, and RBNZ in relation to their statutory powers, and for certain money-management services provided by non-profit organisations. We welcome these exemptions.

Independent trustees

All superannuation schemes, whether open or closed, will need to operate under either a manager licence, or (if a restricted scheme) have a licensed independent trustee appointed to serve on the board of trustees. 

Independent trustees will be subject to a more limited range of conditions when compared with the conditions proposed for other forms of licensees, reflecting the individual nature of their role. This includes a condition that they report and provide all relevant information to FMA where they have reasonable grounds to believe that a serious problem or a governance issue has arisen in relation to any product within the scheme.

Whistle-blowing protections for independent trustees reporting serious problems or governance concerns are still to come. Assuming these are robust and consistent with protections for similar required disclosures under the Act, our only residual concern with this obligation is an apparent presumption in FMA’s proposed conditions that whenever an independent trustee is the only person to vote against a trustee resolution, the scheme has a governance issue. As with others who submitted on the initial regulations discussion paper, we believe this position is unduly strict.

Perhaps the biggest issue for those confident they will satisfy the proposed capability requirements will be the financial resource requirement for professional indemnity insurance. Whilst the proposed licence conditions have the flexibility to allow cover to be at a scheme or individual level, we can seem some difficulties arising in practice.

A further practical challenge for applicants is that there is an uneasy fit between proposed governance and compliance conditions and the individual nature of an independent trustee licence. Those thinking of applying will need to give some thought as to how best to document a personal governance and compliance culture.

When to start

Timeframes for licensing

The timeframe in which market participants must become licensed depends on the type of licence they require, and for fund managers and independent trustees, whether or not they can rely on transitional provisions. A snapshot of the timeline is as follows:

 

When do you want to be licensed?

For the providers of class DIMS there is no choice. Any class DIMS (retail) provider must have their licence by 1 December 2014. However, for continuous issuers and independent trustees it is necessary to consider when, on the spectrum between now and 1 December 2016, they wish to become licensed.

Some of the issues to consider are:

  • Identifying the work plan – how much time and resource will be required to compile and complete the licence application. This should include any organisational or structural changes that will need to be made in order to prepare a successful application. For example, restructuring to ensure appropriate financial resources for each issuing entity and the implementation of any new policies and processes.
  • As part of the overall approach to the Act, considering whether or not to apply for a licence first and then move on to the governance, and disclosure requirements or whether to effectively choose an ‘effective date’ and aim to complete all licensing, governance and disclosure changes at the same time. The FMA consultation paper on minimum standards for fund managers indicates that FMA will need to see a plan for how you will approach the changes to governance requirements and disclosure documentation. Therefore, even if licensing, governance, and disclosure are approached in separate stages it will be necessary to have an overall work plan identified before completing a licence application.
  • Consider the likelihood of the business wanting to establish a new fund within the transitional timeframe. If this is the case, it will be necessary to apply for a licence earlier rather than later.

Some other issues to consider include whether or not to be ‘first off the block’ in the new licensing regime or to watch and learn from the experience of others. We set out a few of these issues in the table below:

early later2

How to start

The FMA consultation papers on minimum standards for the licensing regime provide the most information we have received to date about the requirements for the licensing process. However, the regulations are still being developed, FMA’s minimum standards are consultation drafts only and FMA will only be able to publish the licence application guide once the regulations are finalised. Accordingly, unless you have already determined that your strategy is to apply for a licence as early as possible in the process, there may be some merit in waiting for the final regulations, minimum standards, and in particular the licence application guide before commencing your licence application.

We understand that the licence application guide to be published by FMA will include specific questions and will identify where particular evidence and proofs should be included. We also understand that FMA’s expectation will be that applicants answer those questions specifically and with relevant information, rather than merely attaching a number of policy documents or providing large volumes of paper.

The FMA consultation papers are in relation to the ‘minimum standards and licence conditions’. It is likely FMA will be looking at licence applicants and considering those that are aiming for minimum compliance only compared to those who are seen as truly embracing the new world of financial services. We suspect that those licence applicants who can demonstrate policies and procedures that aim for more than minimum compliance will be looked upon favourably.

We also understand that FMA will be reviewing licence applications with a view to ensuring that applicants are considering their customers and investors first.

Finally, we recommend that fund managers talk to their appointed trustees as early as possible in the process. The corporate trustees have recently undergone their own licensing process and they will no doubt have insights that they can share in terms of preparing a licence application. In addition, trustees are now the frontline supervisors for managed funds. It is possible that FMA will want to see evidence that the trustee has been involved in a licence application process. This may include trustee confirmation that the policies and the procedures the manager states it has in its licence application are in place and are capable of being monitored on an on-going basis by the trustee.

Where to from here?

The deadline for submissions on the draft Regulations is 5 December 2013. The deadline for submissions on FMA’s draft minimum standards and conditions is 12 December 2013.

As the saying goes, the devil is in the detail. Up until now we have only had the framework of the new regime as set out in the Act. Now we have details, and a far clearer idea of what that regime will look like.

Although the sheer volume of consultation being undertaken in the fourth quarter of 2013 is overwhelming, it is important that market participants engage now to ensure that the proposed requirements are workable and will not impose unnecessary compliance costs.

Start a conversation…

If you would like a specific briefing on the Act, the draft Regulations, or the proposed licensing requirements, or would like our assistance with any aspect of the Act or any other financial services issue, please contact David Ireland on +64 4 498 0840, Catriona Grover on +64 4 498 0816, Nick Summerfield on +64 4 498 0876, or email the team at financialmarkets@kensingtonswan.com. 
 

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