In brief:

• Licensing of financial advice providers with a single Code of Conduct to rule all retail financial advice remains the plan
• Greater rigour over the processes for engaging nominated representatives is now proposed
• Increased flexibility in structuring the way financial advice is provided
• Transitional arrangements have been enhanced
• The Code of Conduct will no longer be a service code
• No attempt has been made to distinguish between sales and advice, or to ban commissions
• Implementation timing looks likely to be pushed out.

In full: 

A year ago we launched our Financial Advice Regulatory Reforms series, with each newsletter discussing a different aspect of the reform package. That series followed on from our in-depth February 2017 Financial Law Insight where we comprehensively unpacked the proposed framework.

Much of the previous commentary we have provided remains applicable, despite some fairly strong objections to the reforms contained in the 72 written submissions on FSLAB. That means that, other than timeframes, the overall framework summarised in our August 2017 Financial Law Insight has not changed – a regime reliant on the licensing of financial advice providers, a broadly applicable Code of Conduct, and registration of some (but not all) of those giving financial advice on behalf of a provider.

Perhaps the most significant change in detail is the refinement made to the use of nominated representatives to provide financial advice on behalf of licensed financial advice providers. We will also now have a Code of Conduct that applies to anyone giving financial advice to retail clients, as opposed to a service code that only applies when financial advice is given.

When FSLAB was reported back from the Economic Development, Science and Innovation Committee at the end of July, MBIE produced a fairly comprehensive outline of all of the submission points that had been made on the Bill, and its response to those submission points (including the large number of points raised that it disagreed with and which were not reflected in the second draft). That departmental report is 100 pages long. Whether or not you agree with MBIE’s response to the wide array of submission points, it’s well worth a read if you are interested in the policy rationale behind the law.

In this Financial Law Insight, we share some thoughts on what has changed, what hasn’t, and implications for the way forward.

Nominated representatives

One of the major battlegrounds in the reform process has been the rules around the engagement of nominated representatives, including what they should be called. To refresh, a "nominated representative" is an individual nominated by a licensed financial advice provider to give financial advice on that provider’s behalf, who is not registered as a financial adviser. The closest equivalent under the current regime is a QFE adviser.

The nominated representatives term and concept remain, but with quite a few changes to the rules governing their engagement:

• It will now be possible for a nominated representative to operate under more than one provider’s licence, where authorised to do so under a licence condition related to the use of interposed persons by a provider (see below).
• More significantly, the policy intent of imposing restrictions on the freedom nominated representatives will have when giving financial advice has now been spelled out. Providers will be required to have in place processes and controls to limit the nature and scope of the advice that a nominated representative may give, and that allow the provider to regulate what advice is given and the circumstances in which it is given. This restriction was missing from FSLAB’s first reading.
• The new restrictions go on to effectively impose a statutory compliance assurance burden on providers who choose to nominate representatives to give financial advice on their behalf. This significantly ups the ante. Rather than leaving compliance assurance arrangements to the licensing process, requirements have been elevated to the statutory level, reducing the flexibility the FMA would have had in this regard under the Bill as first introduced.
• No change has been made to the original position that nominated representatives will not be subject to any disciplinary action under the regime, or be civilly liable, in the event they contravene a financial advice duty provision. Financial advice providers are still prohibited from giving or offering nominated representatives any kind of incentive that is likely to have the effect of encouraging them to engage in conduct that contravenes their legislative duties. But that falls short of the ban on commissions some had been pushing for.
• All financial advice providers will now be able to engage nominated representatives to give financial advice on their behalf under a transitional licence. Previously, that ability was going to be limited to QFEs. There are still limitations, but this is a significant freeing up of the transitional rules for non-QFEs.

Engaging third parties in the financial advice process

Another area where there has been a significant shift has been to include the ability for a financial advice provider to use third party entities to provide financial advice on its behalf.

Instead of only being able to engage nominated representatives or individual financial advisers to give regulated financial advice on their behalf, or give that advice themselves, financial advice providers will now be able to engage financial advisers and nominated representatives indirectly through one or more ‘interposed’ persons. They can even engage an entity to give regulated financial advice on their behalf – it’s not limited to individuals. What this sets up is the ability for a licensed financial advice provider to engage employees of third party contractors to give financial advice, with those employees not necessarily giving financial advice on behalf of their own employer.

This new ability only arises if it is expressly permitted under the terms of the licence granted to the financial advice provider and may be subject to limits or restrictions, such as requiring the third party to be registered. This new feature increases the flexibility in the range of models available for the provision of financial advice. It also complicates and potentially confuses the regulatory landscape.

Scope of financial advice

The concept of financial advice has been clarified by expressly including the making of a recommendation or giving of an opinion about switching funds within a managed investment scheme. This reflects the FMA’s existing approach to the issue (see for example, its March 2017 KiwiSaver advice guidance note).

Another tweak to the scope of the regime has been to tighten the concept of "financial advice service" so that it only occurs where given to a financial advice provider’s clients. Restrictions on giving regulated financial advice will also now only apply where that advice is given to a retail client. That’s good. However, financial advice given for internal business purposes with no client involved will still be treated as regulated financial advice, which is odd.

Opportunity has not been taken to expand the "investment planning" limb of financial advice to include a wider class of planning services, as had been submitted by many (including Kensington Swan and the Code Working Group). Instead, ‘financial planning’ of a kind prescribed by regulations can be included within the concept of financial advice in the future. We think this is a cop out. While flexibility is usually a good thing, the uncertainty this creates in relation to what activities might be caught is unhelpful.

Prioritising interests of clients

The new statutory duty to give priority to clients’ interests has been tightened. Where there is a conflict between the interests of a client and the provider’s own interests (or the interests of a person connected with the giving of the advice) the provider is only required to give priority to the client’s interests by taking all reasonable steps to ensure the advice is not materially influenced by those conflicted interests. Previously, there was a concern that the way the duty had been drafted meant that taking reasonable steps was only one of the things the provider needed to do.

The duty remains a conflict of interests prioritisation obligation, as opposed to a client best interests duty. It will only apply where the provider knows (or ought reasonably to know) that there is a conflict, with the steps required limited to ensuring there is no material influence.

We think the final balance struck is about right. However, imposing such a duty where financial advice is given to a wholesale client seems out of step with the position that is otherwise taken in financial markets conduct regulation where wholesale clients are involved.

Financial advice v product sales?

One of the more vocal criticisms of the proposed regime has been in its failure to call out those who only offer a single provider product option as salespeople. Under FSLAB, as soon as you make a recommendation or give an opinion about a particular financial product, you will be treated as having given financial advice and be able to call yourself an adviser, even if you only had one financial product that you could recommend or talk about. This position has not been changed.

We support the approach that has been taken in FSLAB in not creating a statutory divide. Labelling people based upon the extent of the financial products they are able to recommend or express opinions about would inevitably lead to the sort of fine distinctions that plague the current law. We think it is far better to cast the net widely, so as to maximise what is caught as regulated financial advice, and then leave it to the Code of Conduct and disclosure requirements to ensure that clients are aware of the limitations on what the person they are dealing with can advise upon.

Implications for the Code

The nature of the minimum standards in the Code of Conduct has been changed from those that must be demonstrated "when regulated financial advice is give" to those that must be demonstrated ‘by persons who give regulated financial advice’. This change is largely as requested by the Code Working Group, meaning that code standards can apply on an ongoing basis. We think this is a sensible approach.

Where the Code Working Group may have their work cut out is in devising code standards that apply at both an entity and an individual level. This challenge has always been there, but is exacerbated by the new flexibilities that have been included in FSLAB as reported back. One small victory has been achieved in finally replacing the term "continuing professional training" with the more commonly used term "continuing professional development".

Exclusions from the regime

The exclusion for financial advice given in the ordinary course of business by certain professions (such as lawyers and accountants) has been tightened by the addition of a requirement that in order to be exempt, the financial advice must be "an ancillary part of carrying on the principal activity" of the relevant occupation. This proposed tightening of the exclusion will no doubt be welcomed by the financial advice community, although some may argue it does not go far enough. MBIE has signalled it is still consulting with the relevant professional bodies in relation to the revised exclusion, so there might still be some adjustment before the law is passed.

There has also been an expansion to the proposed exclusion of advice given for the purpose of complying with lender responsibilities. Advice will not be treated as regulated financial advice if provided in order to comply with a lender’s lender responsibilities under the CCCFA (refined from what had originally been proposed), as well as if it is provided as a reasonably incidental consequence of complying with those responsibilities (which is new). This new exclusion, as now expanded, is likely to result in a reasonable volume of financial advice activity no longer being regulated. Given the context, we think this is sensible.

Transitional arrangements

The big mover as far as transitional arrangements are concerned is the ability for financial advice providers other than QFEs to nominate nominated representatives under a transitional licence. They won’t have quite as much freedom as a QFE in that regard – a pre-condition is that the provider would need to have engaged individuals other than registered financial advisers to provide class services on its behalf immediately before the commencement of the new regime. Nominated representatives engaged under a non-QFE’s transitional licence will not be able to provide personalised services during the transitional period.

The tightened rules around the limits that must be imposed on a nominated representative and the processes that must be in place, discussed earlier in this Financial Law Insight, will apply during the transitional licence period. That might prove challenging. Nevertheless, we think this new power provides welcome flexibility for the sector in transitioning to the new regime.

A win for some is the fact that renewals of financial adviser authorisations and of QFE status will not be required during the transitional period. In other words, any authorisations that were set to expire during the period between the commencement of the new law and the eventual repeal of the Financial Advisers Act will be treated as continuing. That won’t help those whose authorisations are set to expire in the next few months, but is a pragmatic response to the need to avoid unnecessary costs during this period.

Timeline

There is still a fair amount of uncertainty as to the timing for the implementation of the new regime, given that it remains dependant on the Code of Conduct being finalised. With a first draft of any new minimum code standards yet to be sighted, it would be a surprise if the Code was able to be finalised and gazetted before the first quarter of 2019. We then have a nine-month transition period before the Financial Advisers Act will be repealed and transitional licenses come into effect.

The proposed long stop commencement date for all of the new rules to come into effect is 1 May 2020, and we may well come close to that date before everything is fully up and running.

What now?

We await the release of the first draft of the Code of Conduct, with a reasonably extensive consultation phase set to follow. We can also expect to see further consultations in relation to draft regulations supporting the new regime, including consultation on the revised structure for licensing fees and levies that must inevitably follow, as well as draft disclosure regulations.

Meantime, with the new rules for engaging nominated representatives, financial advisers – and now third parties – largely finalised, planning for the optimum model to adopt for providing financial advice in the new world can now proceed in earnest. While much of the compliance detail remains to be confirmed under the new Code of Conduct, with the report back of FSLAB largely confirming the original direction of the reforms, stakeholders can now progress their planning with some confidence.