Beware the Ides of March?

15 March is a date traditionally linked to bad omens, curses, and misfortune, at least since Julius Caesar a couple of millennia ago in Rome. For the financial services sector, it will now be a date forever linked to the new regulatory regime for financial advice services.

In this Financial Law Insight, we look at some of the key practicalities of the reforms. Will the new regime end up joining the list of things cursed by its chosen commencement date, or will it be a cause for celebration, as was the original sentiment associated with the Ides of March?

In brief:

• The new regulatory regime for financial advice is now in force, and is set to stay
• Getting governance and compliance systems right, and implementing effective record keeping processes, will be critical for financial advice providers’ future success
• Difficulties with the new financial advice disclosure rules will take time to iron out
• Conduct of financial institutions reforms look set to further disrupt things

Succeeding in the new world will require providers to embrace the objectives of the new regime and adopt new processes to make it all work. But in the end, good advice remains good advice, and providing good advice to achieve good customer outcomes is what it’s all about.

In July 2016, the then National party-led Government announced the policy decisions that would shape the new regulatory regime for providing financial advice that is now finally in place, two Governments and a click under five years later. Those policy decisions largely confirmed what most had suspected by the time MBIE’s review of the Financial Advisers Act 2008 kicked off back in 2015: the old regime was broken.

Now we are at the dawn of a new era, the question to ask – if anyone had the time – is whether those in office in five years’ time will form a similar view of the new regime. After all, the previous Financial Advisers Act regime only came into full effect on 1 July 2011, and represented an equally significant ‘once-in-a-generation’ shift from the Wild West days of old. A huge amount of policy thinking and resources went into developing the former regime, only for that supposedly generational change to last less than a decade. Will this one fare any better?

We think yes.

Why? Looking back, much of the Financial Advisers Act regime involved papering over the cracks of a past world that was lacking in targeted regulation. It was accompanied by a shiny new financial service provider registration system that has largely stood the test of time and is continuing, with just a few modifications.

Tellingly, the FSPR regime is comprehensive – all those playing the game are caught. The Financial Advisers Act regime, however, was characterised by a very uneven playing field. A small subsection of advice was tightly regulated and limited to authorised financial advisers (‘AFAs’) who never exceeded much more than 2,000 in number, and just a modest number of quasi-licensed participants in the form of QFEs. The vast majority of advisers and financial advice remained only superficially regulated.

The new regime ushered in by the Financial Services Legislation Amendment Act 2019 (or ‘FSLAA’) makes no such mistake. All forms of financial advice and all financial advisers are subject to much the same level of regulation. Only financial advice that is limited to wholesale clients escapes relatively unscathed.

And that is why we think the bones of the new regime are correctly set. Like them or loathe them, the current regulatory settings should last well beyond the end of the current decade. Inevitably there will be tinkering, and some of that may well be significant, but we can’t see there being much appetite for the overall framework changing anytime soon.

So what are the key aspects that providers are going to need to get right if they are going to prosper in the brave new world? And what do they need to be particularly wary of?

Licensee governance

Financial Advice Provider (or FAP) licensee obligations, and the responsibility FAPs take for advice given on their behalf, are the most fundamental change from the old world.

Critical to a FAP succeeding in the new regime will be right-sizing the processes and controls it has in place to ensure all regulatory advice provided under the umbrella of its licence is compliant with the duties imposed by the FSLAA reforms. For those responsible for the FAP’s governance, that will mean ensuring you have your oversight measures and delegations functioning effectively, with a robust compliance assurance programme in place.

Above all else, make sure that you have the outcomes for your customers front and centre of everything you do, and ensure that focus is properly documented. In the modern regulatory environment, it is no longer sufficient to say that your customers are your number one priority. You have to evidence that focus, and at a governance level you need to ensure you can be confident that ‘customer first’ is actually occurring.

Now we have hit March 15, a FAP’s focus will need to shift from just ensuring it is complying with the new duties. It will need to start working on getting ready for applying for a full FAP licence, if it has not already done so.

Many won’t have the luxury of being able to wait until the end of the two-year maximum period their transitional licence will operate for. The FMA has the power to require some FAPs or types of FAP to go early. Odds are that power will be exercised in some form or other if for no other reason than to avoid a full licence application bottleneck come Q1 2023.

Our advice? Aim to go early – get your systems in place so you are ready to go at a time of your choosing, rather than have that timing forced upon you. For some, assessing the adequacy of their systems and what needs to be done to operate in the new world – having experienced it in operation – may be the lightbulb moment they realise it is now too hot to stay in the kitchen.

If that might be you, there’s an increasing level of regulatory risk if you leave it till the last minute to re-position your business away from needing your own FAP licence. Any honeymoon period in which the FMA might take a light-handed approach to enforcing the new financial advice duties may not last the full two years. You can expect little sympathy if you haven’t got the fundamentals right because you were relying upon the transitional nature of your licence. There is no transition period for legal compliance.

Disclosure

The last few months have seen a frantic scramble from soon-to-be FAPs to get all their systems in place to ensure compliance with the new disclosure obligations. Despite some great initiatives from the Financial Services Council and the FMA to help FAPs and financial advisers come to grips with what is required, at the start of March there still seemed to be a lot of confusion out there.

A large part of that confusion lies in the fact that the new disclosure requirements just do not make sense when it comes to generic or mass-market advice. Posting, publishing or otherwise publicly communicating a view about the merits of a particular product will generally count as regulated financial advice, yet there is no relief from the full force of the disclosure requirements when doing so.

If we were to pick the biggest flaw in the new regime, where the practicalities involved have not been properly thought through in finalising the regulatory requirements, disclosure would be it. The length of time it took to get the detail of the disclosure requirements promulgated is the one black mark in what has otherwise been a pretty impressive approach to the reform process from all involved.

It was only the intervention of Covid, resulting in the commencement of the new regime being pushed back nine months, that saved the sector from a complete disclosure debacle. In our view, the policy settings that promised so much in the way of flexibility and meaningful disclosure have been let down by the detail of the practical requirements. We like the concept of using a website to cover off key FAP information, and a prescribed disclosure response when complaints are received, but the balance of the requirements only really make sense in a personalised advice setting.

Hopefully we will see some implementation amendments to the relevant regulations in a short space of time to make it all a bit more workable, and remove the regulatory discouragement to FAPs providing generic advice. At a minimum we hope to see some guidance in this area from the FMA, to provide FAPs with some comfort around the regulator’s expectations when it comes to what we used to call class advice. Meantime, the sector is left to do its best in this space in trying to make a silk purse out of the sow’s ear that is the Disclosure Regulations.

Offshore providers

We have repeatedly expressed concerns about how the regime was going to deal with the provision of financial advice from offshore. Those concerns remain.

To its credit, the FMA has released guidance for FAPs providing overseas firms’ research reports to retail clients. The pragmatism of that guidance is something we applaud. It will hopefully stop offshore firms being discouraged from allowing generic advice to be distributed to retail clients in New Zealand, which had been one of our key concerns.

Concerns over the practical difficulties in rolling out offshore experts to engage with retail clients remain. Also of concern is the fact that offshore advisers without a place of business in New Zealand are effectively prohibited from registering here, driving underground those that primarily target wholesale clients. We don’t believe that is a good regulatory outcome for anyone. However, we don’t sense any appetite for addressing those concerns anytime soon.

Record keeping

One of the early battle grounds that has played out in the regulatory compliance war has been in relation to what is required to maintain ‘adequate records in relation to your financial advice service’. Possibly the reference to war is not the right analogy: hopefully we are all on the same side, but many providers feel like they are under siege.

In most situations it should be fairly clear what is required, and maintaining good records of client interactions and the discharge of regulatory compliance obligations makes perfect business sense. However, the need to maintain records was a feature of the old regime as well, and it was the most common line of successful enforcement action before the Financial Advisers Disciplinary Committee when considering complaints under the old Code of Professional Conduct for AFAs. Seems advisers have a history of getting it wrong.

We see two main practical challenges with the new record-keeping licence condition:

• The first is the practicalities involved in the face of the need for business efficiency. The fact that an adviser didn’t have time to make an adequate record, or that the adviser only gave generic or class advice, won’t cut it as an excuse. The FAPs that will succeed will be the ones to most effectively and efficiently manage that record-keeping challenge.
• The second relates to digital advice and non-consummated advice conversations. We do not live in a perfect word where every client interaction with a FAP is going to result in the client proceeding to provide their details or otherwise co-operate with the FAP’s record-keeping obligation. In our view, a degree of pragmatism is required here. ‘Adequate’ is not the same as ‘comprehensive’ in this context.

The Code

The new Code of Professional Conduct for Financial Advice Services has been applauded for its relative simplicity and principles-based approach. For the Code Standards relating to ethical behaviour, conduct, and client care we concur.

The Code Standards for competence, knowledge, and skill, however, pose some challenges. Many providers have largely batted those challenges away by relying on the two year competency safe harbour period that many are able to avail themselves of – but the day of reckoning will come for all.

One of the main challenges we have seen is how to go about demonstrating competence, knowledge, and skill in a way that is different to obtaining a Level 5 Certificate, while still covering off the relevant qualification outcomes as permitted by the Code. Despite what some may tell you, obtaining that qualification is not actually required. But uncertainties about how you combine a FAP’s capabilities with the individual adviser’s to meet the Standards has driven many down that path.

Hopefully practices will evolve to provide FAPs with sufficient comfort without feeling forced to put their people through training that is not really needed for their role. And the jury is still out on how best to apply the Code when it comes to digital or generic advice.

Conduct

The proposed regulation of the conduct of financial institutions (the CoFI Reforms) remains a sword of Damocles hanging over the heads of all those involved in providing financial advice and/or distributing financial products. While at the time of writing the Bill bringing those reforms into life is only at the second reading stage, it’s already impacting on distribution arrangements. Expected to be passed into law later this year, it will inevitably cause another shake up for the financial product distribution community.

We continue to push for the implementation of those reforms to be delayed until the FSLAA reforms have had time to bed in. How much success we will enjoy on that front remains to be seen. At the very least, we are hoping proposed relief for distributors who are operating under a FAP licence will be locked into the final form of the CoFI Reforms. Further disruption, however, seems inevitable.

Concluding comments

We understand the FMA has approved over 1700 transitional licences and nearly 1000 authorised bodies so far, covering in excess of an estimated 10,000 financial advisers and 12,000 nominated representatives. The effort that has gone into the roll out of the new regime has been truly remarkable. The FMA, in particular, deserves high praise for the level of its engagement throughout the process.

The new regime may well bring about the end for some, and to that extent the timing of its commencement to align with the Ides of March is fitting. For everyone else, we are confident that this is a well-constructed regime that is fit for purpose for the modern environment. With a few tweaks to iron out the rough spots, it should stand the test of time. The winners will be those who embrace what the new regime has been designed to achieve, and get on with the business of delivering on those objectives.

Start a conversation

If you would like assistance with operating as a financial advice provider, or would like to know more about what the reforms may mean for your business, please contact Catriona Grover on +64 4 498 0816, David Ireland on +64 4 498 0840, Liz Lim on +64 9 909 6341, Pauline Ho on +64 9 909 6345, or email the team at bankingandfinancialmarkets.nz@dentons.com.