Financial services law reform moves into overdrive

David Craig, Partner | Monday 10 December 2007

What a week it's been for financial services law reform. The past seven days have seen the introduction as a bill, or the enactment, of the following pieces of legislation:

• the Financial Service Providers (Registration and Dispute Resolution) Bill (FSP Bill);

• the Financial Advisers Bill;

• the Securities Markets (Substantial Security Holders) Regulations 2007;

• the Securities Markets (Market Manipulation) Regulations 2007; and

• finally, in a more esoteric (but nonetheless significant) context, the Climate Change (Emissions Trading and Renewable Preference) Bill.

This, combined with the recently introduced Reserve Bank of New Zealand Amendment Bill (No 3) (RBNZ Bill), represents the most substantial and wide-ranging law reform in this area in a generation. All told, over 350 pages of new, or impending, law. Financial services lawyers now face the grim prospect of replacing John Grisham bestsellers with Parliamentary Counsel Office tomes as compulsory Christmas reading.

The details of this new law are far beyond the scope of an update such as this. But here is a summary of the key points, together with comments on the significance of the new law for financial service providers.

Financial Service Providers (Registration and Dispute Resolution) Bill

The lead-up to the introduction of the FSP Bill has been flagged in a number of previous issues of Financial Services Quarterly. In essence, this Bill, together with the Financial Advisers Bill and the RBNZ Bill, represents the cornerstone of phase one of the Review of Financial Products and Providers being led by the Ministry of Economic Development. This legislative package is intended to be enacted in 2008, with the infrastructure to be in place by 2010 and a two-year transition period to follow.

The FSP Bill sets up a registration system for financial service providers; and establishes a comprehensive, industry-based dispute resolution system.

Registration

Currently, the only financial service providers with registration requirements are banks, superannuation schemes, building societies, industrial and provident societies, friendly societies, credit unions and contributory mortgage brokers. There is no comprehensive way to identify all financial sector providers and their services, and it is not possible for all of these entities to be monitored. This shortcoming was highlighted by the Financial Action Task Force (FATF), the intergovernmental anti-money laundering organisation, when they last evaluated New Zealand in 2003.

So who will the FSP Bill apply to? It will apply to anyone in the business of providing a "financial service" or a "financial adviser service" (we refer to such persons, collectively, as financial service providers). The scope of a "financial adviser service" is discussed below, in the context of the Financial Advisers Bill. The other term used, "financial service", is defined very widely to include, among others:

• borrowing and lending money;

• managing money or securities on behalf of others;

• providing retail financial leases;

• operating money transfer or FX services;

• entering into derivatives;

• underwriting or placing insurance;

• issuing or underwriting securities or acting as trustee or manager for an issue of securities; and

• issuing means of payment (such as credit and debit cards).

A financial service provider cannot provide a financial service unless that person is registered under the FSP Bill. The main requirements for registration are that the person or its controlling owners, directors and senior managers are not otherwise disqualified (e.g., by virtue of being a bankrupt or the subject of certain banning orders or criminal convictions) and that the person is a member of an approved dispute resolution scheme (ADRS).

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 (in the case of providers of "financial services") or by way of notification from the relevant approved professional body (APB) (in the case of providers of "financial adviser services"). The register will be kept in electronic form and will be searchable by the public. The register will disclose, among other things:

• the name and address of the ADRS (and, if the person is a financial adviser, the APB) of which the person is a member; and

• if the person is required to be licensed (e.g., because it is a registered bank), the name and address of the licensing authority.

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 face.

Dispute resolution

Currently, voluntary industry-based dispute resolution schemes cover most banks and insurance companies, together with many managed funds. However, in many cases in the financial sector, consumers do not have access to appropriate dispute resolution and redress mechanisms due to lack of knowledge about where to go, and complicated and expensive processes.

To address this, the FSP Bill establishes a comprehensive, industry-based dispute resolution system, the key features of which are that:

• the relevant Minister may approve a dispute resolution scheme if it meets specified criteria; and

• membership of an approved dispute resolution scheme will be mandatory for financial service providers who transact with natural persons and small businesses (defined as those with no more than 19 employees).

It is expected that more than one scheme will be approved, and that financial service providers will be able to elect which scheme to join. The system is to be funded by industry. However, there will be a reserve scheme, for financial service providers who are not members of an approved scheme, which will be funded by a levy on members.

Financial Advisers Bill

This Bill does two main things:

• it imposes statutory conduct obligations and statutory disclosure obligations on financial advisers; and

• it establishes a co-regulatory regime for financial advisers, to be overseen by the Securities Commission and industry-based APBs.

The Bill prohibits a person from performing a "financial adviser service" for a member of the public unless that person is registered under the FSP Bill and is a member of an APB. The definition of "financial adviser service" is the key to the Bill's application. Broadly, a "financial adviser service" is the giving of a recommendation, opinion or guidance to a member of the public on financial products or borrowing or investment decisions. The term also includes the handling of money in connection with a financial decision.

Owing to the broad definition of "financial adviser service", the Bill will have considerably wider scope than the equivalent regime currently embodied in the Securities Markets Act 1988 (which applies only to the provision of investment advice, or the receipt of investment money, in relation to securities). This, in turn, will lead to uncertainties as to the exact stage at which a financial service provider's role crosses over into this new regime. For example, a bank discussing with its customer the appropriate mix of fixed and floating rate mortgages should, at some stage, cross over from being a mere product provider to being a financial adviser.

Co-regulatory regime

The day-to-day regulator of a financial adviser will be its APB. The Securities Commission will be responsible for overseeing APBs and recommends approval of APBs to the Minister of Commerce. The cost to a financial adviser of joining an APB has been estimated at $1,000-$5,000.

Statutory conduct obligations

These include:

• the obligation to act with integrity;

• the obligation to exercise reasonable care, diligence and skill;

• a prohibition on engaging in misleading or deceptive conduct; and

• money handling and trust accounting requirements.

Statutory disclosure obligations

These include the requirement to disclose upfront in a disclosure statement:

• the adviser's experience, qualifications and professional standing;

• the name of the APB and ADRS of which the adviser is a member;

• whether the adviser has been convicted of certain criminal offences;

• fees; and

• potential conflicts of interest, including commissions.

Reserve Bank of New Zealand Amendment Bill (No 3)

The purpose of the RBNZ Bill is to put in place some of the framework for the Reserve Bank's new function as regulator of non-bank deposit takers (NBDTs).

The RBNZ Bill will insert a new Part 5D into the principal Act, relating to the prudential regulation of NBDTs. NBDTs are defined as persons who offer debt securities to the public and who carry on the business of borrowing and lending money, or providing financial services, or both. One point to note here is that NBDTs do not include organisations that fund themselves either intra-group or at wholesale level.

NBDTs must have and maintain a credit rating from an approved rating agency. The intention is to exempt from this requirement NBDTs with total assets of less than $10 million. For them, the typical annual credit rating fee of $30,000 is seen as disproportionately high.

For the purpose of overseeing NBDTs, the Reserve Bank is empowered to promulgate regulations:

• prescribing corporate governance and risk management standards;

• requiring a minimum level of capital (likely to be set at $2 million);

• requiring the maintenance of a capital ratio;

• limiting exposure to related parties; and

• imposing minimum liquidity requirements.

Most of these regulatory requirements will be replicated in the trust deed the NBDT uses to issue debt securities. This will reinforce the role of trustees as the frontline supervisor of NBDTs. Trustees, in turn, will be overseen by the Securities Commission.

It remains to be seen whether this "three pronged attack" (Reserve Bank, Securities Commission and trustees) will be sufficient to resolve the problems currently being experienced by the finance company sector. Most likely, the horse has already bolted. It may well be that, by the time this legislation comes into force, the industry will have been through significant consolidation. As a result, it may be the operation of market forces, rather than legislation, that delivers a stronger industry.

Further legislation will be introduced in 2008 dealing with the other aspect of the Reserve Bank's oversight of NBDTs – the licensing of NBDTs and the "fit and proper" requirements for controlling shareholders, directors and senior managers.

The two securities markets regulations

Securities Markets (Substantial Security Holders) Regulations 2007

These regulations set out the form and prescribe the delivery method for substantial security holder notices. The regulations are intended to operate in conjunction with the new disclosure regime set out in the Securities Markets Act, both of which it seems will come into force on 29 February 2008.

Those who have struggled with completing these forms in the past (such as global investment banks with both proprietary and client holdings spread across many jurisdictions) will not be encouraged by the new forms. The details required, and the rules relating to those details, will continue to make this task a difficult and frustrating exercise for some.

Securities Markets (Market Manipulation) Regulations 2007

New sections added to the Securities Markets Act, but not yet in force, will create various new offences relating to dealings in securities. One such offence relates to doing an act that is likely to have the effect of creating a misleading appearance of active trading in securities (or, more simply, market manipulation).

These regulations provide a safe harbour from the market manipulation rules where market stabilisation activities are undertaken in the context of an IPO of at least $30 million. In order to qualify for the safe harbour, those activities must comply with certain requirements set out in the regulations (which, for example, limit the market stabilisation to a period of 30 days from the listing date).

The Climate Change (Emissions Trading and Renewable Preference) Bill

This Bill enables the New Zealand Emissions Trading Scheme (NZ ETS) to be introduced, along with amendments to relevant tax and personal property securities legislation. It also introduces a 10-year moratorium on new base load fossil-fuelled thermal electricity generation, except to the extent required to ensure the security of New Zealand 's electricity supply - a measure to complement the emissions trading scheme.

In brief, the Bill sets out the mechanics of the NZ ETS, including:

• clarification as to which activities give rise to mandatory obligations or the right to participate under the scheme;
  
• who, in terms of a particular activity, will or could be a participant;
  
• details of a participant's obligations, and the penalties for failing to comply with them;
  
• the manner in which liabilities or benefits will be calculated and how units are to be issued or surrendered; and
  
• the basis on which units will be either freely allocated or sold to participants by public tender.

Of particular interest to those in the finance sector will be the rules relating to the operation of the carbon market. The Bill attempts to preserve flexibility for parties to trade New Zealand Units (or NZUs – the primary unit of trade under the NZ ETS) in any manner they choose. This could be via a regulated exchange (such as the NZX's TZ1 exchange) or, say, via an internet-based trading platform.

Trading will be available to anyone eligible to open a holding account with the registry, not just participants. If overseas experience is anything to go by, we should expect this market to be a fertile source of business for those who participate in financial markets generally (such as investment and trading banks). In particular, we should expect the forward market (both exchange-traded and OTC) for NZUs to be actively used by both participants (that is, those with NZ ETS obligations) and market makers.

Financial market players will be interested to note that the regime for taking security over NZUs will mimic that for security interests over shares and other financial products. Adopting a regime familiar to participants in existing financial markets should help promote liquidity and tradability of NZUs.

International trading is recognised and permitted by the Bill, albeit the Minister retains the discretion to restrict the types of emission units that may be traded internationally and enter the scheme, such as certified emission reduction units (CERs) from nuclear projects. Future international linking with other emissions trading schemes is foreshadowed by the inclusion of "approved overseas units" as a type of unit that may be surrendered for compliance purposes.

 

For further information please contact:

David Craig
Partner

Murray King
Partner

Hugh Kettle
Partner

Rachel Gowing
Senior Associate