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UNPACKING THE FINANCIAL ADVICE REGULATORY REFORMS
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The Exposure Draft of the Financial Services Legislation Amendment Bill has finally been released. There are a few surprises, with those interested having until 31 March 2017 to submit on the detail of the proposals.

In brief

The key bits and indicative timing:

  • Overhaul of current designations, all retail financial advice to be subject to Code and provided under licence
  • Transitional provider licensing from Q1 2019
  • Full licensing required by Q1 2021.

The clever bits:

  • Code Working Group to be established to accelerate the new Code of Conduct.

The predictable bits:

  • Licensing likely to suit a range of provider models
  • Abandonment of ‘agent’ term
  • Accountability for advice.

The status quo bits:

  • Existing exclusions and wholesale client relief largely untouched.

The surprise bits:

  • Change in tack for client first
  • Transitional licensing
  • Complete repeal of standalone law for financial advice, to be swallowed up in the FMC Act regime.

In our July 2016 Financial Law Insight we outlined the main policy decisions Cabinet made on the regulation of financial advice. These resulted from the review of the Financial Advisers and Financial Service Providers legislation by the Ministry of Business, Innovation, and Employment (MBIE).

That review heralded a complete reframing of the way financial advice is to be regulated.

In brief, the policy decisions signalled in July 2016 were to the effect that:

  • Financial advice would only be able to be provided to retail clients by or on behalf of a licensed provider
  • The current designations of types of financial adviser, types of financial product that could be advised upon, and types of advice, are to be abolished
  • New concepts, of ‘Financial Adviser’, ‘Agent’, and licensed ‘Financial Advice Firm’ were to be introduced, with the first two needing to be engaged by the third
  • All financial advice would be subject to a Code of Conduct, created by a Code Committee
  • The ‘consumer first’ and base competency concepts from the current Code were to be elevated to the legislation
  • Personalised robo-advice was to be facilitated.

Policy decisions around transitional arrangements, the composition of the Code Committee and its processes, and compliance and enforcement tools, were deferred. These decisions have now been made and publicised with the release of the Exposure Draft.

Initial reaction? The content of the Exposure Draft evokes the full range of emotive responses from ‘Wow, that’s really clever’, through ‘that makes sense’, to ‘business as usual’, and ending with ‘never saw that one coming’.  

In this Financial Law Insight, we deep-dive into what gives rise to each of these reactions. Overall, we think that what MBIE has offered up has some pretty good bones. Some of the good stuff is masked by the complexity of the drafting approach, and the nature of the July 2016 policy decisions meant there were always going to be a few surprises thrown up by the drafting of the detail. There is still room for improvement, but for those genuinely open to moving the financial advice profession forward in a pragmatic fashion, things look pretty encouraging.

Wow, that’s really clever

The expanded form of Code of Conduct that all financial advice must satisfy under the new regime presents one of the most significant transitional hurdles to overcome.

In a nutshell, with prospective Financial Advice Providers needing to demonstrate to the Financial Markets Authority (FMA) that they have adequate processes in place to ensure compliance with the new Code of Conduct, applications for licensing cannot be progressed until the new Code has been finalised. With at least a year’s work likely to be required to develop the new Code, this aspect was shaping as a major handbrake on proceedings. What MBIE has done to release this handbrake is really quite clever, and a refreshing innovation in expediting the implementation of any regulatory reform.

What is proposed is that the Minister of Commerce and Consumer Affairs will appoint a Code Working Group in the first half of 2017, under Terms of Reference that reflect the terms of the Exposure Draft. That way the development of the Code can be progressed immediately, without needing to wait for the draft legislation to work its way through the Parliamentary process.

Ministers appointing working groups is not unprecedented. What is new is a mechanism proposed to be included in the Bill, to the effect that the Code Working Group will automatically transform into the Code Committee when the new law is passed. All the work of the Code Working Group will effectively be ratified at that point as if it had been undertaken by the fully constituted Code Committee.

So rather than sitting on our hands while we wait for the new law to work its way through Parliament, or rushing through parts of the machinery of the new Bill under urgency, this core aspect of the new regime can kick off immediately. That’s smart work.

That makes sense

When considering the Exposure Draft, it is important to remember the key policy decisions that were made in July 2016. Those decisions are not open to be re-litigated at this point, although the outrage that has been expressed over some elements of the new regime suggests some think otherwise.

One of the key policy decisions had been to move to entity licensing, with individuals involved in the financial advice process acting on behalf of a licensee categorised as ‘financial advisers’ (and individually accountable for their actions) or ‘agents’ (not individually accountable).

The inherently problematic term ‘agent’ has been replaced by ‘representative’. That makes sense. The new concept is broadly similar to the concept of a QFE adviser under the current regime. Describing such a person as an ‘agent’ never made sense.

A number of financial advice sector commentators and existing financial advisers have come out in arms against the new term, arguing that they should instead be referred to as ‘sales persons’ or similar. Such an argument effectively seeks to revisit one of the options under the Financial Advisers Act Review that was rejected in the policy decisions made in July 2016. It also flies in the face of the fact that a number of individuals who will be categorised as Financial Advice Representatives under the new regime will genuinely not be ‘sales persons’. The concept is intended to cover a wide range of roles. Hence a neutral term such as ‘representative’ is ideal if we are to avoid the trap that the current regime has fallen into of an excessive number of categorisations of the moving parts of the regime.

As for individual accountability of those at the financial advice frontlines, again we believe the approach taken in the Exposure Draft makes sense – and it is also consistent with the policy decisions made in July 2016. The key thing to remember is that the licensed Financial Advice Provider will be held accountable for the actions of its Financial Advice Representatives in demonstrating compliance with the legislation and the new Code of Conduct.

A focus of the FMA in the Financial Advice Provider licensing process will be to ensure that where reliance is placed on Financial Advice Representatives, the applicant has in place ‘clear and effective processes, controls, and limitations relating to the financial advice that may be given by its representatives’. Applicants are also expressly prohibited from providing incentives intended to encourage Financial Advice Representative to engage in conduct that contravenes the statutory duties required to be discharged in giving financial advice.

Individual Financial Advice Representatives were never going to be registered as financial service providers in their own right. That would have made no sense at all. Not being registered makes it very hard for FMA to hold them personally accountable for their actions.

There is, of course, a risk to the perceived effectiveness of the regime where a non-compliant Financial Advice Representative moves from one licensed Financial Advice Provider to another, with no official ‘black book’ register to keep track of these individuals. That risk will no doubt be mitigated in part by Financial Advice Provider staff on-boarding processes that will be scrutinised as part of the FMA’s review of licence applications. However, the financial advice sector will be looking to MBIE to come up with some further processes to help them manage this risk.

What we really liked about the new regime when the policy decisions were released in July 2016 was the flexibility it gives Financial Advice Providers in shaping their business models to suit themselves when applying for their licence. It was pleasing to see that the Exposure Draft did nothing to diminish that flexibility, with no legislated constraints on Financial Advice Providers coming up with different options for demonstrating the robustness of their financial advice processes to the FMA.

The onus then switches to the FMA to ensure that it has adequate resources and methodology in place to accommodate a wide range of business models – from the very small one-person adviser operation through to the largest ‘big end of town’ mass-market model and businesses wishing to offer robo-advice – and avoids taking a one size fits all approach. The initial noises made by the FMA are encouraging in this regard.

For prospective Financial Advice Provider licensees, we suspect the approach they take in relying on Financial Advisers (as opposed to Financial Advice Representatives) will be a critical factor in determining the makeup of their licence applications.

Business as usual – status quo for carve outs

The current regime provides extensive relief for those only offering financial advice to ‘wholesale clients’. There is also a range of exclusions for occupation-related activities and incidental financial advice.

The continuation of that relief was signalled in the July 2016 policy decisions. While some of the wording has changed, the substance of the existing relief has remained, largely unscathed. In particular, financial advice to wholesale clients won't be provided under a licence. That’s good news for offshore providers engaging with clients from the high end of town, and others for whom financial advice is just a by-product of their core activities.

Those with a mix of retail and wholesale clients will need to look at the way they delineate their service lines if they want to deal with each group under different rules – but that’s hardly a surprise. Where things may heat up a little is the prospect of new conduct and disclosure obligations applying when advising wholesale clients. 

Never saw that one coming

Whenever a new regulatory regime is introduced, one of the big challenges the legislators face is working out how you move everyone from the current state to the new state. When the current regime was rolled out in 2010 and 2011 there was a staggered approach taken, requiring registration under the new Financial Services Provider Register, followed a few months later by the regime coming into full force and effect.

With the recently completed transitional periods applied for the Financial Markets Conduct Act 2013, we saw a two-year period when both the old regime and the new regime were in operation, enabling participants to time their entry into the new regime and allow a staggering of the market services licences required.

When we considered the policy decisions made in 2016, we had assumed the well-beaten recent path of staggering the coming into effect of the various parts of the new law would be followed.

Instead, what MBIE have done is adopt a provisional/transitional licensing approach, very similar to the approach which was taken when insurers first came under their current prudential supervision regime requirements. We weren’t expecting that, but we think this is a smart approach to both expediting the introduction of the new regime, and minimising pain and confusion through that process.

What is going to happen is that all those currently involved in delivering financial advice will need to apply for a transitional licence if they wish to continue in business. The trigger point for that process commencing will be the finalisation of the new Code of Conduct. Would-be licensees will then have six months to secure a transitional licence. This will be a non-qualitative, mechanical process.

Six months after the Code of Conduct is finalised, all transitional licences will come into effect and the new law will be in force. At that point, the current Financial Advisers Act will be completely repealed. Existing Authorised Financial Advisers and Registered Financial Advisers will have the option of committing to a transitional licensee, enabling them to continue to provide the type of financial adviser services they were able to provide under the current regime for a further two years from the new regime coming into effect, without needing to satisfy any new competency requirements under the new Code of Conduct. Call this a transitional ‘stay of execution’ for the new competency requirements, to allow a time buffer to enable current financial advisers to satisfy any new requirements.

We think this aspect of the transitional arrangements is also a smart move. While we don’t know what the changes might be to the current competency requirements under the existing Code of Professional Conduct for Authorised Financial Advisers, there will inevitably be some changes – particularly in the current Registered Financial Adviser space. This approach provides a generous relief period for those individuals to come to grips with the new requirements.

Transitioning existing financial advisers is not going to be straightforward, but at least a clear pathway has been laid out that preserves the status quo for participants for a reasonable period, allowing them to structure business models to maximise the opportunities the new regime will inevitably present them.

Another interesting aspect of the transitional arrangements is that current qualifying financial entities (QFEs) will be able to transition across with both Financial Advisers and Financial Advice Representatives sitting under them, with their QFE advisers at the time of transition automatically morphing into Financial Advice Representatives.

On day one, these will be the only licensed Financial Advice Providers able to operate with Financial Advice Representatives.

The other thing that we hadn’t anticipated was the new regime being brought within the Financial Markets Conduct Act regime, with the Financial Advisers Act being repealed in its entirely.

Moving forward, we agree it makes sense for the regime regulating financial advice to be brought within the Financial Markets Conduct Act, facilitating access to the existing machinery for market services licensing and FMA’s flexible enforcement toolkit under that regime, and providing greater likelihood of a consistent approach being taken.

The downside is that the Financial Markets Conduct Act is one of the most complicated regulatory regimes we have in place in New Zealand. Feeding in another layer of complexity to this regime is not going to make it any easier. Financial Advice Providers who currently enjoy operating outside the Financial Markets Conduct Act regime will be dragged into it, increasing the level of adjustment required. It also makes it harder for participants to get their heads around the detail of the changes, with the Exposure Draft requiring readers to pull together a number of threads to make sense of it all.

The new consumer first duty

The July 2016 policy decisions included a new statutory conduct obligation to place the interests of the consumer first.

Under the current Code of Professional Conduct for Authorised Financial Advisers, ‘client first’ is expressed as a paramount obligation. It does not require consideration of any pre-conditions in order to come into play, and is something Authorised Financial Advisers must abide by 24/7.

The formulation of client first in the Exposure Draft is a very different beast. As currently drafted, it only applies if a person providing regulated financial advice knows, or ought reasonably to know, that there is a conflict of interest at play in giving the financial advice. The client first obligation is then expressed as requiring the Financial Adviser to give priority to the client’s interests.

In our view, this approach is quite different to Cabinet’s consumer first policy decision from July 2016, and the obligation placed on Authorised Financial Advisers in the current Code of Professional Conduct. As drafted, it is purely a mechanism for managing conflicts of interest. What’s more, it is a very widely couched conflict of interest provision, that requires consideration of conflicts of interest with anyone, not just related parties. We see that as a big problem, and will be submitting accordingly.

The drafting of the new statutory conduct obligations gives rise to a number of technical issues. That includes a new requirement to agree the nature and scope of the advice to be provided that has been plucked from the current Code of Professional Conduct out of context. Hopefully all these technical blips will be sorted by the time the Bill is introduced to Parliament. Regardless, the new statutory duties are going to constrain the work of the Code Working Group in developing the new Code of Conduct.

Next steps?

Our discussion above highlights just a few of the elements of the proposed new regime, as outlined under the Exposure Draft. There is plenty more.

In particular, the Exposure Draft does not pick up on the detail of the proposed transitional arrangements, with those being left to the very helpful Consultation Paper released by MBIE in conjunction with the Exposure Draft.

That Consultation Paper throws up a few key issues on which MBIE is still seeking feedback. Included amongst those questions are options for the temporary grandfathering of requirements for existing Authorised Financial Advisers, with the possible option of demonstrating competence through an assessment process for experienced advisers. MBIE have also sought feedback on the possibility of adopting a phased approach to Financial Advice Provider licensing.

The Minister of Commerce and Consumer Affairs has also signalled interest in exploring whether the Financial Advisers Disciplinary Committee should consider complaints against Financial Advisers, and whether Financial Advisers should be solely accountable for breaches of their obligations where the Provider has met its obligations. We think these are points worth submitting on.

The indicative timeframe given by MBIE for the coming into effect of the new regime is for everything to be fully up and running with all transitional licenses in place by around February 2019. The transitional period would then end by February 2021, when full licensing would be in force. This ambitious timeframe is predicated on the new Code of Conduct being finalised and issued by August 2018, with the new law being passed at some point prior to that date.

That timeframe is ambitious, with minimal room to move. Whether or not a Bill can be finalised to be introduced to Parliament this year remains to be seen. If it is not, then everyone will be up against it to make that indicative timing work.

There is also a question mark as to whether or not that is the most sensible timing in any case. With most of New Zealand away at the beach during January, having an early February deadline to have everything in place may not be an optimum approach. With the possibility of businesses wanting to restructure their financial advice propositions in light of the new regime, targeting (say) a 1 April 2019 start date might be a more appropriate way to go.

Regardless, there is still much water to pass under the bridge. For those who have only just completed a challenging couple of years in transitioning to the new Financial Markets Conduct Act regime, it seems we are only going to have a very short space of time to catch our breath before the regulatory reform rollercoaster kicks off on another round, with the development of the new Code of Conduct likely to commence by the middle of this year.

Submissions on the Exposure Draft close on 31 March 2017. MBIE will be on a tight timeframe to consider those submissions and feed them into the final version of the Bill that will eventually be introduced to Parliament. History has shown that submissions and engagement in the reform process do count. This is likely to be the last chance for the Financial Advice sector to materially influence the final outcome.

If you would like a specific briefing on the Exposure Draft or MBIE’s accompanying Consultation Paper, and what the proposals may mean for your business, or would like our assistance in preparing a submission on the proposed reforms please contact Catriona Grover on +64 4 498 0816, David Ireland on +64 4 498 0840, Nick Summerfield on +64 9 915 3357, Karen Mace on +64 4 496 5941, or Tom McLaughlin on +64 4 498 0886, or email the team at financialmarkets@kensingtonswan.com.

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