The FMA's concern
On 31 March, the Financial Markets Authority (FMA) issued a consultation paper aimed at stanching the flow of complaints it has received about online FX and other short-duration derivatives, such as binary options.
In its consultation paper, the FMA notes that short-duration derivatives are responsible for around 40% of the total complaints it has received over the past 18 months. The FMA suggests a link between this high level of dissatisfaction and the emergence of online trading platforms – often offshore-based – offering these products to New Zealand investors.
Under the Financial Markets Conduct Act 2013 (the FMC Act), anyone issuing "derivatives" under a "regulated offer" (broadly speaking, a non-wholesale offer) must be licensed by the FMA. The definition of "derivative" is defined in section 8 of the FMC Act and is further refined in regulation 13 of the Financial Markets Conduct Regulations 2014 (the FMC Regulations). In summary:
- the FMC Act definition has two main parts: the first of which sets out the general prerequisites for "derivatives" (including, in particular, the requirement that they settle in no less than the prescribed future time); and the second of which lists specific transaction types (e.g., futures, forwards, swaps, CFDs, etc.), and
- the FMC Regulations prescribe the "future time" referred to in the FMC Act definition. It is three working days for foreign exchange agreements and one working day in any other case.
To date, the FMA has interpreted these provisions to mean that any foreign exchange agreement settled within three working days, and any other derivative settled within one working day, do not require the issuer to be licensed. This is despite the fact that those products may be one of the listed transaction types in the second part of the "derivatives' definition. Consequently, short-duration derivatives have been largely unregulated in New Zealand.
The FMA's proposal
In what could be described an unconventional approach, the FMA has decided that the potential harm short-duration derivatives pose for investors means that issuers of these products should be licensed. In order to achieve that outcome, the FMA is proposing to change the interpretation it has adopted to date. Specifically, the FMA's proposal is that all issuers of one of the listed transaction types (regardless of duration) must be licensed. That outcome, the FMA says, accords with the intention of Parliament when the legislation was enacted.
The FMA expects all issuers who may be caught by this new interpretation to have applied for a licence by 1 August 2017, and to be licensed and fully compliant by 1 December 2017.
Relief for deliverable spot FX
The FMA acknowledges that Parliament's intention was not to catch deliverable spot FX contracts with a delayed settlement. Such contracts could be considered a "forward" (one of the listed transaction types) and, therefore, under the FMA's new interpretation, a derivative requiring its issuer to be licensed. In order to prevent that unintended consequence, the FMA is proposing to use its designation power to declare that deliverable spot FX contracts that settle within three working days are not derivatives for the purposes of the FMC Act. That declaration would exclude rolling spot contracts, which are one of the listed transaction types in the second part of the FMC Act definition of "derivative".
What to do?
The FMA has invited submissions on its consultation paper. Submissions close on 28 April 2017.
Assuming the changes proposed by the FMA are implemented:
- issuers that only offer deliverable spot FX contracts that settle within three working days need not do anything; their activity will continue to be unlicensed,
- currently unlicensed issuers that offer other short-duration derivatives will need to apply for a licence by 1 August 2017 and be licensed and fully compliant by 1 December 2017 (this would require, among other things, the preparation of a product disclosure statement (PDS) and registration on the financial service providers register), and
- currently licensed issuers that offer other short-duration derivatives will need to check their conditions of licence, their PDSs, and their broader compliance framework to ensure these can accommodate the new licensed products.
If you would like assistance with preparing a submission, or guidance on how this development would affect your business, please contact David Craig 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.