We were joined in our Auckland session by the FMA’s Director of Regulation, Liam Mason, who provided practical balance and context to the debate. In Wellington the frustrations caused by increased regulation and fears of unintended consequences were more apparent. In both centres came the acknowledgment that the world has moved on, and mere compliance with the letter of the law may no longer be enough.
In this Financial Law Insight we discuss some of the themes explored in our ‘Unpacking Good Conduct’ sessions, and look at what’s next for the financial markets regulatory reform juggernaut.
The FMA’s 2019 annual report
The conduct theme of the past 12 months was conveniently highlighted in the FMA’s 2019 annual report released at the end of October, providing a useful insight to the regulator’s focus. Particularly informative are FMA’s articulation of its views as to what delivering good customer outcomes means:
Irrespective of what the regulations may dictate, putting in place business practices to address the above will put any market participant in good stead should the FMA come knocking. But that is not all that the FMA is looking to see. Tellingly, the FMA notes in its report that the high level recommendations from the bank and insurer conduct and culture reviews apply to all financial market participants. No distinction is made between those the FMA regulates and those it doesn’t, as far as the expectations of our key regulator are concerned.
What is the FMA wanting to see from financial product providers and distributors?
The FMA can hardly be accused of hiding its expectations when it comes to conduct.
Historically, many of us have challenged the legal basis for the FMA making such pronouncements, with the FMA’s 2017 ‘Guide to Conduct’ a classic case in point: there’s no strict black letter law to support these expressions regulator expectations. However, we now operate in different times. A key observation from the Hayne Report was that Australian financial institutions acted in the ways that they did because they could. Complying with the letter of the law is no longer enough – that is still required, but ticking the box without considering what else should be done to promote good customer outcomes and lock in good conduct processes is a recipe for an unpleasant meal.
In our ‘Unpacking Good Conduct’ sessions we focussed on how the conduct theme might be put into practical effect in a couple of the major battlegrounds – discharging lender responsibilities and intermediary distribution of financial products.
Lender responsibilities and good conduct
Applying a good customer outcome lens has not been a core requirement for lenders when discharging their responsibilities to consumers under the Credit Contracts and Consumer Finance Act 2003 (‘CCCFA’). In part that can be attributed to the fact that the regulator of those obligations is the Commerce Commission, which has been largely silent to date in the whole financial institution conduct and culture debate. Besides, there is a responsible lending code that provides a safe harbour for the discharge of the lender responsibility principles under the CCCFA, so why do anything different?
We think things are about to change. We see good conduct considerations starting to have an impact on lender practices and related regulatory expectations in a number of ways, such as:
1. The FSLAA lender responsibilities exclusion
The new regime for regulating financial advice to be introduced under the Financial Services Legislation Amendment Act 2019 (‘FSLAA’) contains a carve out for lenders when giving financial advice in order to discharge their CCCFA responsibilities, or as a reasonably incidental consequence of doing so. From a good conduct and consumer outcomes perspective:
The answers to these questions are perhaps no longer found in the letter of the law, but in the expectations expressed by the FMA in its annual report. Answering them incorrectly may not result in a regulatory breach, but will inevitably move you up the queue in the regulators’ risk-based priority list.
2. New consumer lending record keeping duties
The Credit Contracts Legislation Amendment Bill currently before the House contains a number of enhancements to lender responsibilities, including greater responsibility for making reasonable enquiries to ensure lending products are suitable and affordable – requirements that are consistent with a ‘good customer outcome’ focus.
In addition, new requirements to keep records of the enquiries lenders make of consumer borrowers will be imposed, including a requirement to produce records to evidence how their responsibilities have been discharged. Although implementation of the prescribed record-keeping requirement has now been delayed until April 2021, record-keeping is one of the key mechanisms within the control of lenders available to protect and enhance their position.
Adding a ‘good customer outcome’ component to records maintained of consumer lending might be worth considering for those lenders having an eye to the future. Good conduct considerations will inevitably start to play a bigger part in assessing compliance. Locking in good record-keeping processes now, that factor in the FMA’s expectations, can only assist in future-proofing systems.
Simply asking ‘was complying with the lender responsibilities code sufficient to promote a good customer outcome in this particular financing arrangement, or should we have gone further?’, and recording the answer to that question, may go a long way in protecting your position should things go wrong.
3. Future enforcement
In all of the above we have talked of the FMA’s expectations of good conduct. Of course, the FMA is not the regulator of lender responsibilities. That’s the Commerce Commission’s job. So why are the FMA’s expectations of relevance here?
In August this year the Council of Financial Regulators (FMA, MBIE, RBNZ and the Treasury, known as CoFR) announced that the Commerce Commission had joined their ranks as a new member. CoFR’s vision is to maximise New Zealand’s sustainable economic wellbeing through responsive and coordinated financial system regulation.
With the Commerce Commission now part of the CoFR forum, and the emphasis the FMA and RBNZ have placed on financial institution conduct and culture issues over the past 18 months, it will come as no surprise to see concepts such as good customer outcomes and good conduct start to permeate through the Commerce Commission’s work in the consumer credit space.
Arrangements between Providers and Intermediaries
One of the headline talking points from the September Cabinet decisions on regulating the Conduct of Financial Institutions (the CoFI Reforms) was the fact that those subject to the new conduct licensing requirements were limited to banks, insurers, and Non-Bank Deposit Takers (NBDTs), initially at least. What’s more, they would only be accountable for the sales outcomes for their end customers where those sales are made through intermediaries who are not licensed FAPs.
Does that mean that fund managers, derivatives issuers, and DIMS providers are completely off the hook? Does that mean all providers are free to ignore the end outcomes for customers when sales of their products are made through a licensed FAP?
We think not. Banks, insurers, and NBDTs are the immediate focus because that is where issues of concern have been identified in the joint FMA/RBNZ conduct and culture reviews, and where the FMA currently has no conduct leverage. Fund managers (including KiwiSaver providers), derivatives issuers, and DIMS providers are all currently required to operate under a market services licence if offering to retail clients. Fund managers also already have statutory conduct obligations under the Financial Markets Conduct Act 2013. The time may come for them all to be brought within the conduct licensing net, but for now the FMA has levers to pull to regulate their conduct, enabling the CoFI Reforms to prioritise areas where they can have the most impact.
As for provider accountability for their FAP intermediaries, the Cabinet decisions supporting the CoFI Reforms noted that regardless of the distribution channel, providers should take action to ensure the objectives and needs of their customers are met. The CoFI Reforms will introduce regulations and licence conditions to specify the steps licensees must take when dealing with intermediaries, such as arrangements for dealing with the oversight of the intermediary and responsibility for the end customer.
FAPs themselves are not off the hook as far as the CoFI Reforms are concerned. The possibility of further licence conditions being imposed on FAPs to align with the new conduct obligations was expressly reserved in the Cabinet decisions.
So what might this mean in practice? For starters, interests of providers and distributors seem aligned in this space. Both have a regulatory expectation on them to optimise the end customer outcome. Working together to ensure robust systems are in place to support this occurring not only makes good business sense, it will tick a number of regulatory boxes (not that this is just about ticking boxes, of course!).
Does this mean that providers are expected to 2nd guess the advice a FAP provides to its customers? No. But it does mean they can’t turn a Nelsonian eye to the processes their contracted FAPs have in place, and claim that ensuring appropriate financial advice is provided is entirely a distributor issue.
Providing training about their products, setting expectations about good conduct, providing information to help customers with their decision-making, and taking action where they identify activity that might not be in customer interests, fall within the regulatory expectations of providers. We see this playing out in updated distribution agreements, where we expect to see all parties placing greater conduct-related expectations on each other, backed up by monitoring, audit and reporting obligations. Inevitably there will need to be a review of remuneration and incentive arrangements. In light if the Hayne Report findings, avoiding the risk of fees being paid where no corresponding service is being provided should be an important focus, for providers and distributors alike.
A Bill to introduce the CoFI reforms is expected to be introduced to the House before Christmas. Unlike previous reforms in this space, there won’t be time for exposure drafts or extensive consultation – Minister Faafoi wants action, and the policy decisions driving the new legislation are locked down. Let’s just hope that we don’t see the same raft of practical issues arising with the drafting as were identified with the consultation draft of the new disclosure regulations to support the FSLAA regime. (Our submission on the exposure draft can be found here). The disclosure regulations in turn are expected ‘early 2020’, but given the length of time it took to produce the exposure draft we would be surprised to see final regulations much before Easter, leaving FAPs scant time to put all the systems in place necessary to support the final requirements.
Meantime we will have transitional FAP licensing commencing on 25 November, with a number of would-be FAPs lining up to be early adopters, and others taking a more cautious approach. While all this is going on the CCCFA reforms and related regulations will continue working their way through the system. And insurers will need to keep an eye out for the next step in the insurance contract law review project being run alongside the CoFI Reforms, as well as the review of the Insurance (Prudential Supervision) Act 2010 which is set to be resurrected in 2020.
However you look at it, a lot has happened in the financial institutions regulatory reform space over the past 12 months and there’s a lot still to come. One thing is for sure: no financial markets participant can afford to sit back and wait until all the dust has settled before taking action to operationalise the good conduct rhetoric we have been hearing. Those that took that approach with the release of the FMA’s ‘Guide to Conduct’ in 2017 have already been singled out by the FMA for special mention - and not in a good way!
Start a conversation
If you would like a briefing on any aspect of the financial markets and consumer financing regulatory reforms or how to implement and document good conduct processes in your business, or on your financial advice proposition under the FSLAA reforms, please contact Catriona Grover on +64 4 498 0816, David Ireland on +64 4 498 0840, Pauline Ho on +64 9 909 6345, Megan Mcluskie on +64 4 498 0876 or Nick Beresford on +64 9 375 1150, or email the team at email@example.com.