The client money rules in Part 6 of the Financial Markets Conduct Regulations 2014 (the Regulations) are something of an anomaly in New Zealand financial services law. Typically, that law recognises a wholesale/retail distinction – and regulates accordingly. That distinction has certainly been prominent in the re-write of New Zealand’s financial services laws that has occurred over the last eight years.
Part 6 is anomalous because it applies what are essentially retail-focused investor protection rules to trading activity with wholesale investors. For example, “derivatives issuers” (the label given to dealers subject to these rules) trading with wholesale investors must hold client money on trust for investors, must only use that money for specified purposes, and must meet various record keeping and reporting obligations.
While derivatives issuers can take some comfort from the fact that these rules do not apply to wholesale over-the-counter (OTC) derivatives, their application to wholesale exchange-traded derivatives has caused concern. In response to that concern, in November 2015 the Financial Markets Authority (FMA) issued an exemption for US futures commission merchants in the Financial Markets Conduct (US Futures Commission Merchants) Exemption Notice 2015. That exemption exempts US FCMs from compliance with the client money rules, but only in respect of products traded on the NZX derivatives market. Given the small size of that market, and the few products traded on it, this exemption offers limited regulatory relief to an FCM. The FCM must still comply with the New Zealand client money rules in respect of products traded on offshore markets.
That requirement has both surprised, and been criticised by, not just FCMs but also other overseas-regulated futures dealers. They argue that they are already (heavily) regulated in their home jurisdiction, and that issues such as client money protection are adequately covered by that jurisdiction’s laws. Moreover, it should be left to each jurisdiction to regulate activity relating to trading on its financial markets. In that sense, New Zealand is unjustifiably extending its regulatory reach.
It now seems that this view has the support of the FMA. The FMA has said that it will be approaching the Ministry for Business, Innovation and Employment (MBIE, which administers the Regulations) to seek “clarification” that the client money rules do not apply to exchange-traded products traded on an offshore market for wholesale investors.
Bell Gully comment
While offshore futures dealers should welcome this initiative, they should be under no illusion as to what it involves. This would not be a clarification; it would be a law change. That is, there is no doubt that the Regulations, as currently drafted, apply to products traded on offshore markets. So what the FMA would be seeking is a pull-back from the broad ambit of the Regulations.
In the meantime, of course, we are left in an uncomfortable limbo. On the one hand, the FMA has stated that it will not focus on enforcing these rules in relation to trading on offshore exchanges. On the other hand, the current law is clear – offshore trading activities are caught. Futures dealers who do not comply with the client money rules will be in breach of the Regulations and, technically, will be at risk of a court making a “civil liability order” against them. While the FMA would be the person typically expected to seek such an order, an aggrieved client could also do so.
So what should a dealer do?
That depends on a number of things – in particular, the dealer’s appetite for regulatory risk, the likelihood that MBIE would agree to make this change, and the timeframe in which it would do so. The first of those matters varies considerably and is particular to each dealer. The second and third matters are unknown at this stage.
We encourage those dealers affected by these rules to discuss with their usual Bell Gully advisor what approach would be the most appropriate for them.
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.