Financial services law reform clears another hurdle

David Craig, Partner | Friday 12 September 2008

In December last year, a raft of legislation comprising the cornerstone of the Government's Review of Financial Products and Providers (RFPP) was introduced into Parliament. In the last week, with Parliament poised to rise for the upcoming election, that legislation has moved a step closer to becoming reality.

Specifically:

• the Reserve Bank of New Zealand Amendment Act 2008 (the RBNZ Amendment Act) received the royal assent on 9 September;

• the Financial Service Providers (Registration and Dispute Resolution) Bill (the FSP Bill) and the Financial Advisers Bill were both reported back from Select Committee; and

• the Settlement Systems, Futures, and Emissions Units Bill (the Settlement Systems Bill) was introduced into Parliament.

The legislation covers a huge range of financial services activity – from the regulation of specific sectors (such as financial advisers, non-bank deposit takers and settlement systems) to the registration of all financial service providers. All four pieces of legislation have been substantially changed since they were first released. This note updates earlier newsletters covering this legislation. It outlines some of the more significant changes and describes the new regulatory models that will emerge as a result.

1. Financial Service Providers (Registration and Dispute Resolution) Bill

This is the umbrella legislation for the RFPP reform. Broadly, the FSP Bill 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.

Registration

Scope of FSP Bill

The FSP Bill applies to persons who provide a "financial service", including, among others:

• a financial adviser service (this is discussed in section 2 below in the context of the Financial Advisers Bill);

• acting as a deposit taker (this is discussed in section 3 below in the context of the RBNZ Amendment Act);

• being a registered bank;

• managing money or securities on behalf of others;

• lending money;

• operating money transfer or fx services;

• entering into derivatives;

• underwriting or placing insurance;

• participating in the offer of securities to the public as issuer, trustee or manager; and

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

Importantly, however, the FSP Bill 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, the FSP Bill 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 Bill, its employees are not subject to the FSP Bill.

Restriction on providing financial services

A financial service provider cannot carry on the business of providing a financial service unless that person is registered under the FSP Bill. The main requirements for registration are unchanged from the FSP Bill as introduced. That is, the applicant and its controlling owners, directors and senior managers cannot be disqualified (e.g., by virtue of being bankrupt or the subject of certain banning orders or criminal convictions) and the applicant must be a member of an approved dispute resolution scheme if it provides a financial service to the public. The registration process itself is also largely unchanged.

Responsible financial service provider

The amended FSP Bill 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.

Territorial scope

Perhaps the most surprising amendment made to the FSP Bill is the new territorial scope provision. This states that the FSP Bill applies to the provision in New Zealand of a financial service by a person in New Zealand, regardless where that person is resident, is incorporated, or carries on business. The Select Committee commentary says that this is to clarify that the legislation is not intended to apply to "off-shore financial services" (which presumably means financial services provided to New Zealand residents from offshore, and not financial services provided from New Zealand to overseas persons). This runs contrary to the extraterritorial scope of other financial services legislation (such as the Securities Act 1978, the Securities Markets Act 1988 and the Reserve Bank of New Zealand Act 1989), which applies merely by virtue of the relevant activity being carried on in New Zealand or targeting New Zealand residents. There is no additional requirement, under these other regulatory regimes, for the service/product provider to be in New Zealand. The upshot of this would seem to be "buyer beware" when dealing with a financial service provider located offshore.

Dispute resolution

The main change to the dispute resolution provisions relate to which financial service providers are governed by these provisions. Initially, the FSP Bill proposed that only those dealing with individuals or small businesses would be required to be a member of an approved dispute resolution scheme. The proposal now is that anyone providing a financial service to the public should be subject to this requirement. However, in a strange mismatch, only individuals and small businesses (and, presumably, not other members of the public) may make complaints through the scheme.

2. Financial Advisers Bill

The changes to the Financial Advisers Bill are more substantial than those to the FSP Bill. Specifically:

• the co-regulatory model initially proposed (which involved oversight from approved professional bodies and the Securities Commission) has been scrapped. The Securities Commission is now to be the sole regulator; and

• the "one size fits all" approach initially proposed has been replaced by a two-tiered approach, which regulates financial advisers according to the complexity and risk of the products on which they advise.

Regulatory model

The Committee was concerned about the extent of the role that industry would play in the regime initially proposed by this Bill. That role will be significantly diminished now, with the Securities Commission being solely responsible for monitoring industry standards and authorising financial advisers.

Two-tiered approach to regulation

Under this new approach, a "financial adviser" is a person who, in the course of their business:

• gives financial advice (which is a recommendation, opinion, or guidance relating to trading a "financial product"); or

• makes an investment transaction (which is an investment relating to trading a "financial product"); or

• provides a financial planning service.

In turn, "financial products" are of two-types: category 1 products and category 2 products. 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.

The restrictions on financial advisers under the FSP Bill are as follows:

• an individual who is registered under the FSP Bill may give financial advice or make an investment transaction in relation to a category 2 product;

• an individual who is both registered under the FSP Bill and authorised by the Securities Commission under the Financial Advisers Bill may give financial advice or make an investment transaction in relation to a category 1 product or provide a financial planning service; and

• an individual (whether registered or not) who is an employee of what is known as a qualifying financial entity (or QFE) may give financial advice or make an investment transaction in relation to a category 2 product. 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 Financial Advisers Bill. 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 Bill.

Conduct and disclosure obligations

The disclosure and conduct obligations on financial advisers are largely unchanged from those initially proposed. However, the application of these obligations differs depending on what category of product is involved and which of the three types of financial adviser outlined above is providing the service.

Commissioner for Financial Advisers

The Financial Advisers Bill recommends the appointment of a new Commissioner for Financial Advisers as a member of the Securities Commission. The Commissioner's functions include appointing a committee that would be responsible for producing a draft code of conduct for financial advisers. That code would come into force following Ministerial approval.

3. Reserve Bank of New Zealand Amendment Act 2008

The RBNZ Amendment Act establishes the framework for the regulation of non-bank deposit takers (NBDTs) by the Reserve Bank. With finance companies continuing to struggle throughout 2008 as a result of the credit crunch, the Government has been eager to accelerate the enactment of this legislation.

The main changes made since the Bill was introduced include:

• the addition of a transition period to allow NBDTs 18 months to comply with the new credit rating requirements;

• new governance requirements for NBDTs, such as the need for two independent directors; and

• the requirement for an NBDT to have a risk management programme in place and approved by its trustee.

It is clear from these changes that, in many respects, NBDTs will be regulated in a manner similar to registered banks.

4. Settlement Systems, Futures and Emissions Units Bill

The Settlement Systems Bill contains legislation that, in part, will support the emissions trading scheme legislation passed earlier this week. However, the reforms set out in this Bill will not only affect ETS participants.

Most of the Settlement Systems Bill is devoted to replacing the current payment system regime in Part 5C of the Reserve Bank of New Zealand Act. The intention of the change is to extend the statutory protection currently available only to designated payment systems to designated settlement systems. That is, systems that settle both payment and non-payment obligations (such as the NZX's proposed clearing house for carbon trades) will be able to benefit from the finality rules in the new Part 5C.

Significant changes to this new regime since the consultation draft released earlier this year include:

• in the case of "pure payment systems", shifting from a joint regulator model (involving the Reserve Bank and the Securities Commission) to a sole regulator model (involving just the Reserve Bank); and

• no longer requiring changes to a settlement system's rules to be approved in advance by the regulator(s).

 

For further information please contact:

David Craig
Partner

Murray King
Partner

Hugh Kettle
Partner

David McPherson
Partner