This blog post was first published as an article on the business law website

Proposals are before New Zealand’s Parliament to reform the law that requires New Zealand financial service businesses to register on the Financial Service Providers Register (“FSPR”).  Reform is needed to address flaws in that law that have allowed some offshore companies to use the FSPR as a “register of convenience”.  However, the reforms will, in my view, make it more difficult for New Zealand to sustain and develop a globally oriented financial services sector including in the growing FinTech sector.  That’s because the reforms will prevent some legitimate NZ-based companies with offshore customers from registering on the FSPR, and will require some registered companies with offshore customers to issue warnings with their services.  The reforms do not appear to take into account key government policies including diversifying New Zealand’s export base.

Other small countries, including Singapore and Ireland, have developed successful export-orientated financial services sectors and are providing substantial support to develop the FinTech sector.  New Zealand has failed to leverage its own inherent advantages to develop the full potential of those sectors and the proposed reforms will, in my view, make it more difficult to do so in some areas.

In this article I background the issues and propose a different approach to reform, based on Cygnus Law’s submissions to the Parliamentary Select Committee considering the reforms. That approach would require a business to have substantive operations in New Zealand as the key pre-condition for registration on the FSPR (and would prevent those that don’t have substantive operations from registering in some cases).  It would also support greater regulator oversight of businesses with offshore customers (which would be funded by the registered companies).  I think that approach to reform better meets the goals of minimising register misuse, complying with New Zealand’s international obligations, and supporting New Zealand as a place to develop (and base) globally-orientated financial service businesses.  I also consider the importance of developing a strategic plan at government level to provide for more cohesive and effective regulation and development of the financial services sector.

FSPR background

New Zealand is a member of the Financial Action Taskforce (“FATF”), an international body that combats money laundering.  A key member commitment is to ensure that all financial service businesses are licensed or registered. The FSPR was established in 2010 for that purpose.  The FSPR is a register of New Zealand financial service businesses- those businesses need to be registered to provide financial services.  A key pre-condition for registration, based on a FATF requirement, is that none of the controlling owners, directors or senior managers of such businesses are “disqualified”.  Grounds for “disqualification” include being convicted of certain crimes and being banned from managing a company.

The reform proposals arise from flaws in the “territorial scope” provision in the law governing the FSPR.  That provision was twice substantially re-written after the law was enacted in 2008.  It brings financial service companies with a “place of business” in New Zealand within the scope of the law and therefore registration.  Some offshore businesses have met the “place of business” requirement by establishing New Zealand companies with small New Zealand offices but with no intention of setting up substantive operations in New Zealand.  The FSPR has become, in effect, a “register of convenience” for such companies.  In some cases those companies have implied that they are NZ-based businesses or that registration is a type of licence (it is not a licence, which requires a company to meet higher standards).  Factors contributing to that issue include that New Zealand companies were not required (until May 2015) to have a NZ-resident director, and that New Zealand does not have a full licensing regime for financial services (other countries do, including Australia).

Proposed reform

To resolve misuse changes to law are being considered by Parliament.  The key change is another rewrite of the territorial scope provision (the third rewrite in 10 years).  The new provision sets a pre-condition for registration as having a specified minimum number of New Zealand customers (rather than having a “place of business” in New Zealand), where companies do not meet other pre-conditions including holding a New Zealand licence.

If the reforms are passed some NZ-based financial service companies with customers mostly (or entirely) offshore will not be required (or able) to register (including because there is no applicable licence for the services provided).  However, the unregistered companies will still be permitted to provide financial services and will, in some cases, be able to be owned and managed by disqualified persons.  Also, some registered companies will be required to provide a warning to their offshore customers, even if they have substantive operations in New Zealand.  That approach creates a “Catch 22” for legitimate and compliant NZ-based business servicing customers off-shore- they may not be able to register or may otherwise have to provide warnings to customers.  So they may have very real difficulty in establishing their credibility in New Zealand and offshore (where FSPR-type registers are common).

Using the number of New Zealand customers as a pre-condition for registration is inconsistent with the original policy goals, including meeting New Zealand’s obligation under FATF to register and regulate New Zealand financial service companies.  The reforms will create new opportunities for misuse.  For example, draft regulations propose that a company will be able to register without needing to have any New Zealand customers and that it will have a 6 month “grace period”.

The proposed changes should, in my view, support (rather than discourage) legitimate financial service businesses that have established (and that want to establish) themselves in New Zealand.  New Zealand is an attractive place to locate such businesses, including because of the relative ease of doing business, our relatively close position to Asian markets, our innovative culture and an existing ex-pat population that is keen to engage with their home markets.

A comparable opportunity existed prior to 2010 with respect to “captive” insurance companies.  They were self-insurance vehicles set up by offshore companies to benefit from New Zealand’s relatively permissive regulatory regime.  Rather than supporting New Zealand as a place for such companies to continue operating, changes to the law in 2010 made it much more difficult for captive insurance companies to operate.  Other countries, including Singapore, have seen the opportunity and have established regimes to encourage the operation of captive insurance companies.

Reduction in regulator oversight

 The reforms appear to be focused, in part, on limiting the obligation of regulators to oversee the activities of New Zealand businesses with offshore customers.  I don’t think that is consistent with New Zealand’s international obligations, enhancing New Zealand’s reputation as a well-regulated jurisdiction, or supporting New Zealand as a place to operate export-orientated financial service businesses.

This is not the first time reforms have aimed to reduce regulator oversight in response to misconduct offshore.  The response to the activities of some NZ-registered building societies outside New Zealand in recent years was to remove them from regulator oversight.  These aren’t the traditional conservative, member owned, building societies.  They are closely-held building societies (often with a single ultimate owner and no NZ-resident director) set up under New Zealand law that can conduct any type of business, anywhere in the world (Cygnus Law has made submissions previously on changes to law to address this issue).

While it is clearly necessary to address factors that may cause reputational damage, I don’t think the right response is to, in a sense, deregulate the entities that cause concern.  There are issues that can and do lead to reputational damage in other export-focused sectors, including poor quality education providers servicing foreign students, falling water quality because of farming intensification, and over-crowded tourism hot-spots.  The response in those cases is to take targeted measures to try to resolve the issues rather than reducing oversight.

Other sectors, including tourism, primary production and film-production, benefit from pro-active support from the government and its agencies, to facilitate their growth and the generation of export revenue.  Similar support has not generally been provided to the financial services sector.

The relevance of strategy

There has been, in my view, a general lack of guiding strategy and focus at government level, over a long period, with respect to the financial services sector. This has led to less than optimal outcomes (though there are other contributing factors), including failures of law and regulatory oversight that led to the collapse of the “finance company” sector from 2006 to 2009.  I think that the lack of strategy also explains why we are now substantively rewriting the FSPR territorial scope provision for the third time in ten years.

The absence of a strategic approach to the sector may also explain, in part, why New Zealand banking sector assets are 95% overseas owned, a very high proportion even among comparable countries.  While New Zealand has a healthy financial services sector, New Zealand misses out on the many benefits that follow from greater local ownership and control.

There have been occasional attempts to address high levels of overseas ownership of and the low level of export income generated by the sector.  The establishment of KiwiBank (an initiative of the late Jim Anderton) has been a significant success.  John Key tried to set in motion the development of a New Zealand managed funds sector servicing offshore customers in 2009.  A working group report supported the concept but officials and other politicians did not and it did not proceed.  In contrast, the film production sector (a service industry) has received significant support to attract business to New Zealand, including funding to kick-start productions, significant tax breaks and changes to law (including, controversially, to labour laws).

The only recent focused initiative to support the export of financial services from New Zealand is the “Asia Region Funds Passport” regime between New Zealand, Australia, Japan, South Korea and Thailand.  The regime will allow large, highly regulated, fund managers in each country to offer domestic managed funds to investors in the other countries via “passporting” rights.  It’s unclear whether New Zealand will ultimately gain much from that regime, especially following the failure to implement John Key’s proposal to develop that sector.

While attention and resource has been directed at the passporting regime, the most interesting, and potentially valuable, developments in the financial services sector are being progressed through FinTech businesses.  In contrast to the sector being championed via the passporting regime, FinTech businesses are generally relatively small and nimble and are arguably in greater need of supportive regulatory initiatives.  However, I don’t think the export potential of that sector has been properly considered nor is there an overarching strategy supporting development of that sector.

Trade policy considerations

The FSPR reforms don’t appear to take into account trade policy and New Zealand’s role in a globalised, and increasingly interconnected, world.  The Ministry of Foreign Affairs and Trade’s (“MFAT”) “Trade Agenda 2030” highlights diversification of exports as a necessary step to help support export growth.  It notes that “overseas investment, trade in services, and the digital economy are growing parts of our trading future.”  The reforms to the FSPR do not support that goal in my view, by making it more difficult for New Zealand to develop (and to attract to New Zealand) export-orientated financial service businesses.

The proportion of New Zealand exports comprised of services is significantly lower than in comparable countries (after factoring out transport services, which are relatively high because of New Zealand’s isolation).  The internet, ultra-fast broadband and other factors mean that New Zealand can export more services, including financial services.  Countries such as Ireland and Singapore show that small advanced countries can develop and sustain a successful export-focused financial services sector.  MFAT, Ministry for Primary Industries and other parts of the public sector oversee export-oriented industries effectively so the financial services sector agencies should be able to do that also.

An alternative approach to reform that supports key policy goals

I think that there is an approach to reform of the FSPR that will allow New Zealand to better leverage its natural advantages and that will support development of financial service businesses (including FinTech) and export diversification.  That approach would require all businesses that want to register on the FSPR to have substantive operations in New Zealand (where they are not otherwise licensed), with some exceptions.  That approach is relatively simple and would resolve the issue that led to the reforms, which is the use of the FSPR as a “register of convenience”.  Substantial New Zealand presence will allow regulators to better oversee the activities of those businesses and to take action in the event of misconduct.  New Zealand companies that don’t have the required operations in New Zealand would not be permitted (in some cases) to operate financial service businesses.  Registration, oversight and enforcement activities can be self-funding through charging higher fees to companies that are focused on servicing offshore customers.

A sector-wide strategy needed?

 The FSPR reform highlights, in my view, the difficulty of implementing regulatory reforms in a complex world in the absence of a strategic plan at government level.  In the absence of a strategic plan there is a risk that actions (or inactions) in the future will result in less than optimal outcomes.  There are good initiatives being advanced currently including moves to open up New Zealand’s payments infrastructure and the Financial Markets Authority’s use of its powers to permit roboadvice services.  However, those initiatives do not appear to be informed by an overarching strategy, so there’s a risk that the right resources are not being applied to the right areas at the right time.  The Australian and UK governments have both developed overarching FinTech strategies.

The new coalition government has expressed real interest in increasing the export of services, which will be essential as it moves to place restrictions on activities that lead to substantial greenhouse gas emissions.  It would be good to see government initiatives that take a long-term view of the financial services sector’s development and that provide a sound strategic and policy underpinning for further reforms.