Last month the FMA opened its consultation on a draft Guidance Note that sets out the FMA’s expectations for the way financial institutions should engage with intermediaries that distribute their products and services under the new CoFI regime (‘Intermediated Distribution Consultation’).

In this Financial Law Insight we look at some of the headline themes and overall approach taken in the proposed guidance. There are some immediate takeaways for both sides of the intermediary relationship, which is good, but also a feeling of expecting something more...

Background

The Financial Markets (Conduct of Institutions) Amendment Act 2022 (‘CoFI Act’) sets out the framework for the long-awaited conduct licensing regime for banks, insurers and deposit takers operating in New Zealand (‘CoFI Regime’).

While the CoFI Regime is not expected to be in full force until early 2025, licensing of financial institutions caught within the net of the CoFI Regime is expected to kick off in a few months. There is much preparatory work to be done by all those affected in order to prepare for the go live date. The clock is ticking to have everything in place in time, including contractual arrangements with intermediaries – the third party distributors of the products and services financial institutions provide.

We have previously commented on the final shape of the CoFI Act (see here). One of the more contentious aspects of the framework has been the extent to which intermediaries are caught up in the CoFI Regime. That aspect was subject to a last minute change in scope when the legislation was finally passed in June last year, with the Intermediated Distribution Consultation feeding off that change.

In the second half of 2022, the FMA conducted a limited series of targeted workshops with financial institutions and intermediaries to explore the issues arising from the new regime. The Intermediated Distribution Consultation is the initial output from the FMA that had been anticipated from those workshops. Does it deliver on the sector’s expectations?

Principles-based guidance – lots of pastry but no meat in the pie?

The proposed guidance isn’t controversial and shouldn’t pose any problems for financial institutions or intermediaries. However, there is a question over how much it advances the conversation. A lot of words are used to say little more than repeating a few key concepts. Perhaps this is just a feature of principles based regulation – when it comes to the crunch, it can be difficult to pin things down and clearly articulate what needs to be done in practice.

Although the financial institutions caught by the CoFI Regime’s net are all licensed by RBNZ, they range in scale and sophistication. Some have fairly simple business models and products while others are large with diverse offerings of services, products, and multiple distribution channels. That makes sector wide guidance that adds value a challenging proposition.

‘One size fits all’ guidance, like that proposed in the Intermediated Distribution Consultation, runs the risk of being too open to be of any particular use. At best, what it does is bust some myths about what financial institutions must have in place with their intermediaries in order to discharge their new regulatory obligations. And maybe that is enough for the proposed guidance to be of value. At least financial institutions are free to determine what makes sense in their dynamic, without being tied down by more prescriptive guidance.

What we would like to see is the FMA produce more focused guidance or FAQs tailored to specific scenarios to supplement the guidance proposed in the Intermediated Distribution Consultation. This could provide added certainty for the likes of credit unions and various types of insurers who range from member focused operations to not-for-profits to local subsidiaries or branches of global institutions.

So what’s useful?

The guidance provides extensive leeway for financial institutions, stating that the design of fair conduct programmes should be tailored to the particular institution’s business. The FMA reiterates that financial institutions can comply in a proportionate and risk based manner. So essentially it is entirely up to each institution to decide how to comply. Which is ok, until such point that the FMA says it is not ok. This is already apparent in the guidance.

Relax on the oversight

The FMA raises concerns that financial institutions are already over-egging their compliance activities, particularly regarding the intensity and frequency of intermediary reviews. The FMA states that it does not expect financial institutions to undertake constant surveillance of intermediaries nor monitor the advice or sales of individuals. So lighter touch general oversight and spot file review will likely suffice. It is helpful to have this clearly stated in guidance – although an institution could still run into trouble if an intermediary’s conduct is later found to be deficient. Such tension is inherent in any principles based regime.

Client communications

When considering communications with clients a key issue will be determining who has primary responsibility for those communications, and ensuring customers are treated fairly with the targeting of communications. In our view, the financial institution must take the lead on these matters as it is their products and services being sold.

Any delegation to an intermediary must be clear, avoid overlaps, and recognise that the intermediary will have a separate set of regulatory obligations at play (such as conducting suitability assessments for their customers). Effective collaboration in managing client relationships will be critical – the CoFI Regime raises the stakes to a new level.

Training and accreditation

The FMA also suggests that financial institutions provide training (or even accreditation) to intermediaries to ensure they understand product features and to keep them updated on any changes to the product. Such training is not a legislative requirement but makes sense to ensure products are not mis-sold. Again, this is a useful prompt to include in the guidance, although it heightens the regulatory risk for financial institutions who are relatively light touch on that front.

Pick n mix

What the proposed guidance implies is that the CoFI Regime will, in practice, require a number of compliance documents and support staff in order to ensure the minimum requirements are met –the various systems, processes, policies, and controls the FMA often mentions – along with a high level approach to valuing customers (which is really just a good way to do business). Principles need to be boiled down to actions, things to be done, and things to be measured.

Shared responsibility?

The FMA suggests, several times in the proposed guidance, that financial institutions and intermediaries ‘share responsibility’ under the CoFI Regime to treat customers fairly. That’s not quite right (the FMA likely picked this idea up from an initial MBIE discussion document). Responsibility, and the relevant obligations under the CoFI Regime, fall on financial institutions – it is up to them to ensure there is compliance with the fair conduct principle.

After all, it is banks, insurers, and deposit takers that are being licensed in respect of their conduct towards consumers. And it is these institutions that must comply with their licensee obligations and fair conduct programmes.

Intermediaries are not directly subject to the fair conduct principle or statutory obligations related to fair conduct programmes. However, intermediaries still have significant obligations under, and related to, the CoFI Regime – primarily complying with restrictions on incentives and any additional regulations that are introduced which impact on their day-to-day operations.

Intermediaries will also need to adhere to the commercial terms agreed with financial institutions regarding distribution and training in respect of the institution’s products and services, as well as ongoing oversight and monitoring. These will simply be contractual obligations rather than legislative ones (although largely driven by the statutory requirements being placed on financial institutions). So it is not so much a shared responsibility regulatory regime, but a regime that requires those caught in its net to collaborate with others to ensure compliance and desired fair customer outcomes.

FAP v Non-FAP intermediation

The Intermediated Distribution Consultation confirms that an intermediary that holds a FAP licence poses a reduced level of risk to consumers, compared to intermediaries that do not hold a FAP licence. This means any financial institution dealing with licensed FAPs can reduce the oversight requirements it needs to put in place. That is, distribution via a licensed FAP should, due to the FAP’s own regulatory obligations, align with the fair conduct principle.

Some financial institutions may therefore look to restrict their distribution channels to licensed FAPs (and other licensed entities) to reduce the burden and risk arising under the CoFI Regime.

Non-licensed intermediaries (primarily those distributing with a ‘no advice’ model, or operating under a licensing exemption such as those whose main business is not the provision of financial services) may therefore find themselves under increasing pressure. This is a logical outcome of the CoFI Regime and it is good to have that clarity in the proposed guidance.

What is also good is that the proposed guidance does not go so far as to insist that financial institutions only distribute through licensed FAPs. Non-licensed intermediaries remain a legitimate distribution channel for financial institutions, recognised by the law. It’s just that their operating model is likely to face additional scrutiny and cost.

Financial institutions as intermediaries

There will also be instances when a financial institution will be an intermediary for another financial institution. A common scenario will be banks selling an insurer’s product, with a grey area existing for white label products. The financial institutions will need to agree which entity has responsibility for the product or service (and therefore which entity’s fair conduct programme covers that product or service). Attempting to put in place some sort of ‘overlapping responsibility’ for such products will create confusion, no matter how well-intentioned.

Financial institutions will not need to include a third party financial institution’s product within their own fair conduct programmes (as those products are already covered by the other institution’s programme). And as far as intermediary conduct goes, financial institutions pose even less risk than licensed FAPs. An intermediary that holds a CoFI licence should be treated as such, i.e. a financial institution does not need to impose controls over another financial institution’s conduct. The proposed guidance briefly touches on this point (in an example), but in our view more could be made of the good conduct assurance provided by distributing through other licensed financial institutions.

What value attestations?

As we’ve mentioned previously, it is inevitable that financial institutions will need to enforce some level of effective oversight of their intermediaries’ conduct, even if those intermediaries do not need to strictly follow an institution’s fair conduct programme.

Attestation may provide a useful record of compliance. However, the FMA suggests such an approach is at the lighter end of compliance measures, and may only be useful for lower-risk distribution methods.

For higher-risk methods a quasi-regulatory return, along the lines of those the FMA collects, might form part of a more methodical approach. Such a return could seek information regarding number of products sold and the extent of any advice provided, confirmation of distribution channels, and number of internal and external complaints received and resolved.

Higher-risk products might require a yearly review. For lower-risk products, a two or three yearly review cycle might suffice on the basis a yearly attestation is provided. Under the proposed guidance, financial institutions are given free rein to determine the nature and frequency of any reviews required. Having that flexibility confirmed is good, although financial institutions and intermediaries will be left to strike their own balance.

We were surprised that greater weight was not placed on the value of third party/independent attestations or audits. While we are pleased that requiring intermediaries to incur the costs involved has not been proposed as a default assurance option, we see external independent attestations as having a valuable assurance role to play.

Submissions

There’s probably not a lot to say in response to the Intermediated Distribution Consultation given the lack of specifics. As mentioned, the FMA isn’t suggesting anything controversial or unworkable, and the concepts put forward make sense. But if there were any particular angles you feel should be reinforced, you have one last chance to get them in the mix.

If you do want to make a submission, you have until 14 April 2023 to do so.

Start a conversation

If you would like to discuss any aspect of the CoFI regime and its implications for your business, or would like assistance with preparing a submission in response to the FMA’s Intermediated Distribution Consultation, please contact Catriona Grover on +64 4 498 0816, David Ireland on +64 4 498 0840, Mark Schroder on +64 9 375 1120, or Zenas Kim on +64 9 914 7268 or email the team at bankingandfinancialmarkets.nz@dentons.com.