Although to many it seems a classic example of reactive law making, legislation has now been passed in New Zealand to provide regulatory protection for investors in financial products.
The financial crisis has exposed the limitations of New Zealand's very light-handed regulatory system. Essentially, anyone was able to act as a financial adviser. There were no legal requirements around education, qualifications or membership of professional bodies.
The first step in the reform process was made in February 2008. The Securities Markets Amendment Act introduced a mandatory requirement for financial advisers to provide clients with a "disclosure statement" before giving advice on investment securities. The new legislation goes much further and imposes "conduct" standards (such as the requirement to act with integrity and exercise care, diligence and skill) on anyone who offers financial advice (including those who advise on life insurance, property insurance and mortgage broking). The new reg ime will differ significantly from the existing regime in that it will apply to those providing financial advice solely to wholesale clients. Currently, the relevant regulations only apply where advice is provided to the retail market. This will require a significant change in practice for many market participants.
The new regime is contained in two separate Acts – the Financial Advisers Act 2008 (the FAA) and the Financial Service Providers (Registration and Dispute Resolution) Act 2008 (the FSP Act).
The FAA was passed in September 2008 and will be introduced in stages. The legislation is expected to be fully operational by the end of 2010. Parts of the FAA came into force on 5 December 2008 (under the Financial Advisers Act Commencement Order 2008), which will allow officials to start work on its implementation.
The stated policy behind the FAA is to promote "the sound and efficient delivery of financial advice and to encourage public confidence in the professionalism and integrity of financial advisers". To achieve this outcome, the FAA has adopted a tiered regulatory approach for financial advisers based on the nature of financial adviser service provided and the complexity of the financial product involved.
Financial adviser service
A "financial adviser" is a person who, in the course of business, performs a "financial adviser service". A "financial adviser service" is performed if a person:
Different requirements will apply to the different services.
"Financial products" are of two-types.
Category 1 products are complex products, such as futures contracts, real property or securities (other than call debt securities or bank term deposits).
Category 2 products are more simple products, such as call debt securities, bank term deposits, non-investment insurance products and consumer credit contracts.
Restrictions on performing financial adviser services
The FAA provides for three types of financial advisers. Each of the three types of financial adviser is subject to a different level of regulation in relation to performing a financial adviser service. The three types of financial advisers are:
Authorised financial adviser
This represents the highest level of authorisation and therefore comes with the most onerous registration and compliance obligations.
To be an authorised financial adviser, the individual must be both registered as a financial service provider under the FSP Act and authorised by the Securities Commission under the FAA.
An authorised financial advisor is able to give financial advice or make an investment transaction in relation to both category 1 products and category 2 products, and provide any type of financial planning service, subject to the terms of the authorisation granted by the Commission. Authorisation can be granted for one or more of the following classes:
The FAA specifies criteria that a person must meet in order to order to obtain authorisation, including the requirement for the individual to be a person of good character, and meet specified levels of competency, knowledge, and skills for an authorised financial adviser.
An individual who is registered as a financial service provider under the FSP Act (a registered adviser) may give financial advice or make an investment transaction in relation to a category 2 product only.
An individual (whether registered as a financial service provider or not) who is an employee or agent of what is termed a "qualified financial entity" (QFE) may, in the course of the QFE's business, give financial advice or make an investment transaction in relation to a category 2 product. Employees of a QFE may also give financial advice or make an investment transaction in relation to a category 1 product of which the QFE is the issuer.
The QFE status rule is intended to allow large organisations to avoid the excessive compliance costs that would otherwise result from the requirement to register all employees who give financial advice. Once the Securities Commission grants this status, the QFE becomes responsible for the conduct and disclosure obligations of its employees under the FAA. If an organisation does not have QFE status, both it, and each employee who performs a financial adviser service, must be registered under the FSP Act.
The FAA provides that a financial adviser must make certain disclosures to the person for whom the financial adviser service is performed, before performing the financial adviser service.
The disclosure obligations under the FAA will replace the investment adviser disclosure requirements in Part 4 of the Securities Markets Act 1988, which will be repealed when the FAA is in full force.
The FAA requires financial advisers to comply with certain conduct obligations. As with the disclosure obligations, the conduct obligations that apply will differ, depending on which of the three types of financial adviser is providing the financial adviser service.
However, all financial advisers must comply with certain basic conduct obligations - such as exercising reasonable care, diligence and skill and not engaging in misleading or deceptive conduct. Authorised financial advisers are subject to additional conduct obligations in relation to handling clients' money and property.
Amendments are scheduled to the section dealing with the territorial scope of the FAA. For some unknown reason, the version that is currently law today in New Zealand differs from the version that was passed by Parliament.
The version that was assented to by the Governor-General (and therefore became law) includes the following section:
"This Act applies to a financial adviser service performed in New Zealand by a person in New Zealand, regardless of where the person performing the financial adviser service is resident, is incorporated, or carries on business."
When it is amended, the FAA will apply to a financial adviser service that is provided to a person in New Zealand, regardless of the location of the financial adviser. Put another way, financial adviser services provided in New Zealand from offshore will be subject to the FAA. We expect this change to be made well before the regime comes fully into force in 2010.
Broadly, the FSP Act does two things. First, it sets up a registration system for financial service providers. Secondly, it establishes a dispute resolution system that will be available to certain complainants.
Prior to the introduction of the FSP Act, there was no general licensing or registration regime for entities providing financial services in New Zealand. There were sector specific regimes (most notably for entities that wished to trade as banks) but a person could, for example, act as a money lender without any need for registration and without any direct regulatory oversight.
The FSP Act now requires all financial service providers to be registered and all financial service providers providing services to the public to be members of an approved industry-led dispute resolution scheme. Once the register and the dispute resolution scheme have been established and approved, and those affected have had an opportunity to comply with the legislation, consumers will be able to search the register via the internet and to make complaints under the dispute resolution scheme. This process is currently expected to take up to two years.
The FSP Act applies to persons who provide a "financial service", including, among others:
However, importantly, the FSP Act only applies to those in the business of providing a financial service (although this may not be the only, or even the principal, business of that person). Moreover, it does not apply to specified persons (such as lawyers, accountants and real estate agents) who perform a financial service as a necessary but incidental element of their business.
Where the financial service provider is an organisation, and the organisation is registered under the FSP Act, its employees are not subject to it.
Responsible financial service provider
The FSP Act introduces the new concept of a "responsible financial service provider". If an entity is declared by Order in Council to be a responsible financial service provider, that entity becomes responsible for the financial services provided by its affiliates (who would not need to register separately). The intention of this amendment is to prevent unduly burdensome compliance costs in certain businesses where registration by each affiliated financial service provider would provide little benefit to consumers.
The registration process will be overseen by the new Registrar of Financial Service Providers and Financial Advisers – initially to be the Registrar of Companies. Registration will be by way of application. The register will be kept in electronic form and will be searchable by the public. The register will disclose, among other things:
For the vast majority of financial service providers, who are not currently regulated, the initial registration requirement, and the requirement to update their details annually, are additional compliance costs they must meet.
Unlike the territorial scope of the FAA (once amended), the FSP Act territorial scope provision states:
"This Act applies to the provision in New Zealand of a financial service by a person who is in New Zealand, regardless of where the financial service provider is resident, is incorporated, or carries on business."
Accordingly, issues may arise over the different application of each piece of legislation to offshore financial advisers. This different treatment, and the resulting consequences for offshore financial service providers, is baffling. By way of example, an offshore financial adviser providing his or her services in New Zealand (but from offshore) will need to comply with the FAA's disclosure and conduct rules. But that person will not need to register as a financial service provider under the FSP Act. It defies logic for two pieces of such closely-related legislation to have a different territorial scope.
The enhanced regulation of financial advisers is certainly a welcome development, and should help to rebuild confidence in New Zealand's financial markets. However, as with all significant new legislation, there are a number of questions around how the new regulation will operate in practice. All participants in New Zealand's financial markets will need to have a clear understanding of these new laws as they evolve over the next few years.
For more information on any of the cases, articles and features in Financial Services Quarterly, please email Rachel Gowing or call on 64 9 916 8825.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.