On Friday 7 August 2020, the Finance and Expenditure Select Committee reported back to Parliament on the regulation of financial institutions' conduct in the Financial Markets (Conduct of Institutions) Bill, commonly referred to as COFI.
By a majority, the Committee has recommended a number of changes, many of which reflect concerns raised by the industry. There is greater detail of the fair conduct principle and fair conduct programme; more limited requirements to publish fair conduct programmes; simplified regulation of intermediaries; greater constraints on regulating incentives; a longer transition period; and a five-year statutory review.
We set out below the Committee's key proposals, as well as some notable omissions.
Greater detail on the fair conduct principle
The Bill requires financial institutions to comply with the fair conduct principle, under which customers must be treated fairly.
A number of submissions to the Committee expressed concern at the limited detail of the principle provided in the Bill. We submitted that the Committee consider providing more guidance as to the requirements which are derived from the principle in the Bill.
In its report, the Committee agreed that the Bill as drafted provided “little guidance" as to what the principle means in practice. It has proposed that the principle be defined as including:
paying due regard to consumer's interests,
acting ethically, transparently, and in good faith,
assisting consumers to make informed decisions,
ensuring that relevant services and associated products are likely to meet the requirements and objectives of likely consumers, and
not subjecting customers to unfair pressure or tactics or undue influence.
Importantly, the list is non-exhaustive with the Committee saying that its intention is that the principle “reflect changing societal norms".
While we welcome the further guidance provided in the Committee's proposals, some of the concepts used—such as the requirement to act “ethically"—are inherently contestable, and other terms already used in other contexts—such as “good faith"—have resulted in considerable litigation as to their meaning.
Greater detail on fair conduct programmes
Many submitters also called for greater detail as to the content of a fair conduct programme. The Committee has picked up on these concerns, observing that leaving details of the requirements to regulations “would not provide certainty", and recommending changes so that the Bill contains the high level requirements for these programmes, but with a regulation-making power to add additional requirements that are “necessary".
Under the Committee's proposals, a fair conduct programme must ensure that the financial institution is:
regularly reviewing relevant services and associated products to determine whether they continue to meet the requirements and objectives of consumers and whether enhancements or improvements should be made,
identifying, monitoring and managing conduct risks through clearly defined roles and responsibilities, regular and comprehensive reporting about those risks to the board or other governing body, and maintenance of records,
identifying conduct that does not comply with the fair conduct principle and taking reasonable steps to mitigate any actual or potential adverse effects of non-compliance,
undertaking initial and ongoing training of employees, agents and intermediaries and checking that training has been completed and is reasonably understood,
obtaining reasonable assurances that employees, agents and intermediaries are competent, fit and proper,
setting conduct expectations for employees, agents and intermediaries, monitoring how consumers have been treated by such persons, and establishing robust and transparent procedures for dealing with misconduct,
designing and managing incentives, and
communicating with consumers in a clear, concise and effective manner.
The Committee also recognised that a fair conduct programme is not a “one size fits all" set of processes and procedures that hold every financial institution to an identical regulatory standard. Rather, the Committee proposed that a financial institution's fair conduct programme should reflect the nature, size and complexity of its business, its relevant services and associated products, the methods by which it provides them to consumers, the types of consumers it deals with, the intermediaries it works with, and any other matters as may be prescribed by regulations.
More limited requirements to publish fair conduct programmes
Some submissions to the Committee had questioned the Bill's original requirement for financial institutions to make copies of their fair conduct programmes publicly available. In response, the Committee has recommended amendments that will only require a financial institution to provide a copy of their fair conduct programme to the FMA and make a summary of key aspects of the programme publicly available.
Licensing requirement has been retained
The Committee has retained the requirement in the Bill for financial institutions to obtain a market services licence under Part 6 of the Financial Markets Conduct Act 2013 (the FMCA). The Committee has however recommended a regulation-making power that would exempt specified types of financial institutions from the requirement to hold a licence. This will reflect existing exemption powers available under the FMCA.
Simplified regulation of intermediaries
The Committee has recommended changes to simplify the regulation of intermediaries. The duty on financial institutions to take “all reasonable steps" to ensure intermediaries comply with their fair conduct programme has been removed. Nor will intermediaries have a corresponding duty to take “all reasonable steps" to comply with the financial institution's fair conduct programme.
Instead, the regulatory obligation will fall exclusively on the financial institution through the content of its fair conduct programme. Each financial institution will be required to make provision in its fair conduct programme for managing and supervising intermediaries (including training, obtaining assurances as to competence, fitness and propriety, setting conduct expectations and dealing with misconduct).
Greater constraints on incentive regulation
One of our key concerns with the Bill was that the power to regulate incentives was too broad and should be more directly focused on addressing conflicted remuneration. We also considered that the basic parameters of incentive regulation should be addressed in the Bill rather than delegated to secondary legislation.
The Committee has gone some way to addressing these concerns by proposing additional constraints on the power to make regulations restricting incentives. In particular, the responsible minister must have regard to a range of matters including the fair conduct principle, whether the regulations are likely to address conflicts of interest or otherwise mitigate adverse effects on customers, the effect of regulations on the financial services industry, and whether the matter being considered is best dealt with by an amendment Act rather than regulation.
The Committee has also narrowed the duty on intermediaries to comply with incentive regulations. That duty will only apply to incentives offered to intermediaries who give regulated financial advice, are involved in negotiating, soliciting, or procuring contracts or carry out other services that are preparatory to the contract. Intermediaries who assist in the administration or performance of the contract will not be subject to incentive regulation.
Extended transition periods and ministerial review
The Committee has proposed longer transition periods for the Bill. Under these proposals, the final deadline for the Bill to come into force has been pushed back one year (to now be three years after it receives Royal Assent) and the requirement for financial institutions to hold a market service licence will be phased in over five years (rather than four).
The Committee has also recommended that the responsible minister conduct a review of the effectiveness of the proposed conduct regime and report back to Parliament within five years of the Bill coming into force.
Changes to definitions of consumer contracts
The Committee has amended the definition of “consumer credit contract" to exclude loans to family trusts (as per the Credit Contracts and Consumer Finance Act 2003). The Committee has also amended the definition of “consumer insurance contract" to capture situations where a bank is a master policy-holder of a contract that provides general insurance for the benefit of consumers.
Enforceability of duties
The Committee's report does not comment at all on enforcement of the fair conduct principle and the associated statutory duties in the Bill. It therefore appears that the Bill will be enforceable in the same way as any other provisions in the FMCA. That is, consumers can bring proceedings directly against financial institutions for breaches of the duties in the Bill (e.g. by seeking compensatory orders under the FMCA). We remain of the view that there are good arguments that the Bill should not create duties that are actionable at the suit of anyone other than the FMA (particularly during the early stages of the new conduct regime).
The Financial Markets (Conduct of Institutions) Bill will now proceed to its second reading, which will take place after the general election in September.
Our cross-practice group is closely monitoring the passage of the Bill (and the formulation of related regulations) and will continue to highlight key developments.
If you have any questions on the proposed reforms please get in touch with the contacts or your usual Bell Gully adviser.
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.