The New Zealand Government has released a paper setting out proposals for further regulation of the conduct of banks and insurance companies.  I outline the key proposals below together with my views.  Submissions on the paper can be made up to 7 June 2019. The government has also released a paper on insurance contract law reform, which also addresses some conduct matters (the submission deadline for that paper is 28 June 2019).

The Government proposes having a bill in relation to conduct reforms before Parliament by the end of 2019.  Given the ambitions set out in the conduct paper, even if that deadline is met I think it is likely to take some time for the bill to be passed into law and for the financial institutions to transition to a new regime.

Background Issues

The proposals for further regulation in the paper follow the damning report from the Australian Royal Commission (ARC) on the conduct of banks and other financial institutions (see my comments on the report here), and the FMA & RBNZ’s reports last year on the conduct of New Zealand banks & insurers.  The paper notes key concerns with the banking and insurance sectors, including:

• A significant imbalance of knowledge and power between the institutions and consumers.
• Weaknesses in governance and management of conduct risks.
• Market-based solutions are not sufficient to ensure good conduct.
• Products are not always designed with good customer outcomes in mind.
• Sales are prioritised over good customer outcomes, with sales incentives encouraging mis-selling.

The analysis of issues in the paper is not as detailed as usual (a separate issues paper is usually prepared to support the development of an options paper), reflecting that the Government is fast-tracking the law reform process.

Preferred Options for Regulation

The paper sets out the preferences of Government for a new conduct regime, comprising:

• Duties that Support Good Customer Outcomes:  A set of overarching duties (described below) with a proposal for directors & senior managers to be personally liable for breaches.
• Improved Claims Handling:  A duty to handle insurance claims in a fair, timely and transparent manner.
• Controls on Conflicted Remuneration:  A duty to design remuneration to promote good customer outcomes, which would apply at all levels of the organisation, reflecting a key recommendation in the ARC report.  The other key measure is a ban on target-based incentives including “soft commissions”.  However, the government does not support the option of general caps on commissions (which are currently applied in Australia for life insurance) or a prohibition on in-house remuneration and incentives linked to sales.
• Improving Product Suitability & Distribution:  Preferred measures are a duty to design products with customers in mind, a requirement for banks & insurers to take greater responsibility for third party distribution, and a power for the regulator to ban products with “particularly poor customer outcomes”.  I note below my concerns with a requirement to monitor the conduct of third party financial advisers (particularly independent advisers), who are separately regulated.
• Enforcement Tools:  A range of penalties and enforcement tools to encourage compliance and to respond to non-compliance.  The preferred option does not propose a licensing regime, which is listed as an option in the paper.  Overall, the preferred enforcement regime appears balanced.  I query below whether the current law has been enforced effectively.

The paper includes a number of other reform options, some going considerably further than the preferred options.  Those options include outright bans on certain types of products (e.g. funeral cover, payment protection insurance), a requirement to settle insurance claims within a set time, and extending the proposed new regime to other providers such as fund managers.  Given the Government’s preferences at this stage I think it’s relatively unlikely that most of those options will make it into the new law.

Duties that Support Good Customer Outcomes:  The proposed duties that are intended to support good customer outcomes are:

• Consider and prioritise the customer’s interest, to the extent reasonably practicable.
• Act with due care, skill and diligence.
• Pay due regard to the information needs of customers and to communicate in a way which is clear and timely.
• Manage conflicts of interest fairly and transparently.
• Ensure complaints handling is fair, timely and transparent.
• Systems and controls in place that support good conduct and address poor conduct.

While many of these duties make sense in the context of services (e.g. sales conduct, claims handling), and are likely already being complied with in many cases, a question is whether the duties can be effectively applied to products and their design.  Such matters involve consideration of internal resources, systems and processes, and commercial decisions including on pricing.  A key question is whether a regulator is better placed than the provider and the market to assess what is appropriate in those areas.

Commentary

A balanced response:  The Government’s preferred options are a reasonably balanced response to the issues identified and do not go as far as the ARC recommendations.  However, the preferred options are still ambitious and represent a significant change to how banks and insurers have been regulated to date.  A lot of detail still has to be worked out.  I comment below on what I see as some key issues with the proposed new regime.

Existing conduct law not being enforced:  Like the earlier RBNZ/FMA reports, the paper dismisses, with very little analysis, the effectiveness of the existing law governing the conduct of banks & insurers.  That law includes:

• “Fair dealing” rules prohibiting misleading & deceptive conduct, and unsubstantiated representations.
• Financial Advisers Act (FAA) provisions imposing responsibility (and liability) on banks & insurers in some circumstances for the conduct of third party advisers.
• The qualifying financial entity (QFE) regime in the FAA under which the FMA approves licences for companies to provide direct financial advice through their adviser workforces, and monitors the conduct of the licensed QFEs. Many banks and insurers are QFEs.  Licence requirements include that the QFE has processes to ensure reward structures drive appropriate behaviors and that advisers consistently guide customers towards suitable products.  QFE conduct in relation to insurance replacement was criticised by the FMA in a July 2018 report.
• Service suitability and quality standards in the Consumer Guarantees Act, which apply to contracts of insurance and customer agreements with banks. Standards in the Act are not enforceable by regulators.

The paper highlights a number of examples of poor conduct that appear to constitute breaches of those existing laws.  However, in the last 5 years neither the FMA nor the RBNZ have brought court proceedings, or taken any other public regulatory action, against a bank or insurer for misconduct in relation to customers.  That may be because the existing law is inadequate.  However, over the same period the Commerce Commission has successfully completed dozens of court and regulatory enforcement actions for breaches of equivalent law.  Targets included large companies such as Spark, Vodafone, Noel Leeming, and Steel & Tube.  Over that period the Commerce Commission also concluded actions against ANZ Bank and Tower Insurance in relation to conduct that largely occurred before 1 April 2014, when the FMA took over responsibility for fair dealing in relation to financial products & services.  If existing laws are not being complied with or enforced are new, more extensive, laws going to be any more effective at addressing the same misconduct?

Market-based solutions not supported: The paper dismisses market-based solutions, based on a limited analysis of limited examples.  The report, in effect, presupposes that further regulation is the appropriate response.  As a result ways that market solutions could be supported to provide an effective response to some concerns are not considered, for example:

• The paper does not fully take into account the important function that financial advisers provide in the market including to address the imbalance of knowledge & power highlighted as a key issue. Rather, the paper proposes imposing obligations on banks & insurers to monitor and control third party financial advisers.  That risks eroding the independence and effectiveness of third party financial advisers (a risk that is acknowledged in the paper).  The paper could have considered ways of supporting consumers to better access independent advice including via roboadvice.
• The paper notes that comparison websites for general insurance are not available in New Zealand because insurers won’t make the required data available. The paper concludes that comparison websites are not an effective measure.  The insurance contract law review paper is more positive about comparison websites.  An option that should be considered is regulatory support for comparison websites, in particular a requirement for insurers to release data to support such websites.  Regulations that require KiwiSaver schemes to disclose fees and costs in a consistent way have been very effective- such disclosure helps to identify issues and supports consumers to make better decisions.

In addition, the FMA has a power to regulate KiwiSaver scheme fees via the obligation in law that fees must not be unreasonable.  In practice that power appears to have had little, if any, impact generally.  Simplicity KiwiSaver (a not-for-profit provider) has entered the market offering significantly lower fees than incumbents.  This highlights that greater regulator powers, including in relation to fees, do not guarantee outcomes better than the market can achieve.

Cross-selling controls not considered: A key recommendation in the ARC report was a ban on cross-selling during a meeting or call with a person for another purpose.  In New Zealand banks have been criticised for cross-selling, including of KiwiSaver schemes. However, cross-selling issues and potential responses are not addressed at all in the paper.  While it was always unlikely that a similar ban would be implemented in New Zealand, the ARC’s concerns about cross-selling, and the issues in New Zealand, mean that cross-selling issues should have at least been considered in the paper.