On 20 August 2024 the Commerce Commission unveiled its final report into competition in the personal banking services sector. The report’s unsurprising conclusion is that the dominance of the four large Australian-owned banks has led to a lack of effective competition and excess profits.  The Commission makes a series of wide-ranging recommendations to improve competition. The Government has pledged to implement them. The recommendations, once implemented, will have a significant impact on mortgage advisers, their financial advice providers (FAPs) and aggregators. This blog post was written by Simon Papa. A version of this blog post was published by TMM Online.

Mortgage adviser recommendations

The recommendations specifically in relation to mortgage advice are intended to increase competition, by allowing customers to access better information and mortgage offers from more lenders. Those recommendations are:

Financial advisers will immediately identify some issues with the recommendations. It’s possible that some of the recommendations will look somewhat different once implemented.

The goods news for advisers

Perhaps the best outcome for advisers is that the Commission has largely stepped away from its criticism of the advice sector contained in its March 2024 draft report. That followed effective submissions and engagement from the sector, as well as information provided by the Financial Markets Authority. The report now focuses more on the role mortgage advisers and associated businesses can play in improving competition in the mortgage market. And, if it is of any comfort to advisers, the Commerce Commission did not pull its punches with respect to regulators and other market participants. In particular, the Commission asserts that there are shortcomings in some aspects of the Reserve Bank’s approach.

The Commission does not recommend a move away from commission-based payments, or changes to commission structures.

In my view it’s possible that the recommendations in relation to mortgage broking will have the largest immediate impact on competition. This reflects that, as the Commissions notes, “home lending [is] the key value driver in [the large banks’ business]”. It also reflects that the Commission’s two key recommendations, better capitalisation of Kiwibank so it can be a market disruptor, and implementation of open banking, will likely take longer to implement, and that their effectiveness is inherently less certain.

The road ahead

It’s clear that the recommendations, if implemented, will have a significant impact on the mortgage advice sector. It may lead to a reduction in business, particularly if the public has greater access to more information on interest rates and other lender information. Workloads may also be increased, by requiring advisers to make more applications. But this may be offset by benefits arising from other recommendations including that banks improve their systems for mortgage applications and make offers more comparable.

Improving transparency

The Commission considers discretionary discounting and cashback offers in some detail. It considers that these lead to a lack of price transparency, hindering consumers’ ability to compare loans. The Commission was influenced by feedback from advisers that they tend to focus on credit policies rather than interest rates, on the basis that lenders will match market leading rates regardless.

One recommendation to address this is that lenders “should present offers in a readily comparable manner” via an “effective interest rate” that factors in cashbacks.  The Commission acknowledges concerns with that level of prescription and suggests that what is implemented will be informed by consumer testing. While well-intentioned, prescription will likely lead to attempts to redesign products to avoid full disclosure. Also, overly prescriptive rules could stifle innovation, ultimately reducing competition.

It is difficult to see how a duty to advise clients of better headline rates will help, unless those headline rates themselves factor in cashbacks and other incentives

A potentially more effective solution might be to require banks to make their lending data accessible to all, supporting advisers as well as fostering the development of platforms that provide detailed and nuanced information to the public. While this might reduce the demand for traditional advice services, it aligns with the Commission’s goal of enhancing price transparency without the drawbacks of prescriptive regulation.

A best interests duty

The Commission proposes that advisers “become champions of price competition” and states that advisers “need… to go further to promote the best interests of consumers”. The Commission effectively recommends replacing the adviser duty to prioritise client interests in the event of a conflict, with a duty to act in clients’ best interests. A best interests duty would cause advisers to become fiduciaries with wider obligations to clients. The wider obligations that the Commission envisages are to identify lenders who are not in the adviser’s (and FAP’s) panel of lenders, and to identify better headline interest rates offered by lenders outside of the panel. The Commission says that this would align with the law in Australia.

Shortcomings in that approach are obvious and were highlighted by advisers in their engagement with the Commission. One obvious issue is that there are many lenders in the market. Also, there is strong evidence that disclosure does not significantly affect customer behaviour in any case. The Commission notes that but does not address it. The Commission seems to assume that this will push advisers towards offering whole-of-market advice, but it is unclear whether this would happen in practice and exactly how much this would increase effective competition.

The obligation to highlight better headline rates may also have limited impact, if these rates do not account for cashbacks and other incentives. The Commission acknowledges that this requirement could reduce adviser income. It suggests that, in response, advisers shift to a fee-for-service model. However, this could inadvertently reduce competition, by discouraging consumers from seeking advice.

Navigating complexity

The report notes that in 2003 the Commission approved ANZ’s purchase of National Bank. The Commission concluded at the time that any loss of competition from creating a bank with about 40% market share would be less than substantial, despite that being well outside of the Commission’s safe harbour for market concentration. That conclusion was based on the Commission’s assumption that ASB would act as a disruptor that “is unlikely [to] have an incentive to participate in coordinated market power to maximise profits, at the expense of its expansion.” The Commission does not address the fact that its assessment was overly optimistic. In fact, one of its two key recommendations is that Kiwibank be better capitalised, in order to act as a disruptor.

If nothing else, the National Bank episode highlights that markets are complex. It is often difficult to intervene in markets without creating further problems and unintended consequences. That’s not to suggest that the Commission hasn’t undertaken an impressive level of analysis and engagement in preparing its report. It clearly has. But in my view the wide scope of its considerations, and the complexity of the market, mean that some areas have not been given the degree of analysis they deserve. The result is that the Commission is unlikely to be right in all respects, as I’ve suggested.

There will be further opportunities for the public to engage during the required law-making process, so the Commission’s recommendations are not the last word.

The Commission has taken bold steps to reshape the personal banking services market.  The journey from recommendation to implementation will require careful navigation, to avoid the risks that arise from such sweeping changes.

 

 

The Financial Markets Authority has released an updated guide on the obligations of client money or property service (“CMPS”) providers. The guide replaces the original 2014 guide. The most significant change since 2014 is the addition of guidance for custodians, who are one type of provider. We consider the updated guide below and proposals to improve the relevant law under the Financial Markets Conduct Act (“FMC Act”). This blog post contains summary information only, is not legal advice and is based on the law as at the date of the blog post. This blog post was written by Simon Papa and Brandon Lim.

The guide is relevant to various types of financial service providers (“FSPs”) that receive, hold and/or transfer money and financial assets (including shares, bonds) on behalf of clients and investors. That includes stockbrokers, discretionary investment management service (“DIMS”) providers, portfolio administration service providers, some types of crypto-asset service providers, and some issuers of financial products. The guide is also relevant to any FSP that deals with providers, even if the FSP is not itself a provider. The guide is not relevant to retail managed investment funds and their custodians, derivatives issuers, and some insurance intermediaries (see the Insurance Intermediaries Act), who are each subject to their own regulatory regimes. NZX listed entities have additional obligations under listing rules.

The core attribute of providers is that they receive and hold money and property on trust for clients, and use them as directed by clients. This can be contrasted with FSPs such as banks (as one example), who do not hold financial assets on trust but enter into a debtor/creditor relationships with clients.

Key provider obligations

The guide addresses key obligations of providers under the FMC Act and regulations, and FMA’s interpretation of those obligations. We consider the guidance on custodian obligations separately below. Key matters addressed in the guide include the following (that guidance has not changed substantially since 2014):

Custodian obligations

Additional obligations apply to providers who are “custodians”. A custodian is a provider that “holds” (rather than simply receiving or transferring) client money and property in relation to financial products (with some exceptions). Custodian obligations include the obligations noted above for providers generally as well as:

These obligations and others were implemented in direct response to the David Ross Ponzi scheme that was identified in 2012. However, they were a piecemeal response that, in our view, have failed to properly address all underlying risks.

FMA identified that the custodian servicing Barry Kloogh, another financial adviser who operated a Ponzi scheme, often sent reports to Kloogh, rather than his clients. In the guide FMA addresses that by interpreting the custodian obligation to obtain client addresses for custodian reports as an obligation to ensure that “the address specified by the client [is] the client’s own address”. That is a strained interpretation of the law. However, it is likely in the interests of custodians to follow the guidance, as any misconduct by an FSP engaging the custodian may have serious consequences for the custodian.

Some FSPs are not required to engage independent custodians. Such FSPs can provide all CMPSs themselves including custodian services and reporting is not independent of the FSP (DIMS providers are one exception- they must ensure that client money and property are held by an independent custodian).

Also, FMA provides detailed guidance in the guide on the use of electronic reporting platforms.

Responsibility for client money or property services at law

Only the entity with the immediate contractual relationship for such CMPS is regulated– outsourced providers of CMPSs that are engaged by that entity are not regulated. In our experience some relevant client contracts, and contracts between FSPs and providers of CMPSs, are unclear with respect to exactly who has relevant CMPS obligations. In the guide FMA notes that as a concern. It creates real risk of non-compliance and of unintended assumption of responsibility. For FSPs that are providers, or who engage providers, it is critical to clarify in contract the extent to which the FSP is (or is not) providing CMPSs (including custodial services) and the other party’s corresponding role and responsibilities. So we recommend that FSPs and providers carefully prepare and/or review relevant contracts in that regard.

See also FMA’s “Custodian’s obligations information sheet”. The information sheet is based on repealed law but the replacement law is largely unchanged.

Wholesale clients

The obligations under the CMPS regulatory regime apply to CMPSs provided to retail clients only, with some exceptions. Following the Ross Ponzi scheme, the categories of wholesale clients in relation to CMPSs were significantly narrowed (reflecting that many Ross clients were, at the time, categorised as wholesale clients). The result is that clients who may be “wholesale” in relation to some financial products and services, may not be wholesale in relation to CMPSs. Clients can choose to opt out of the wholesale categorisation. So, providers should not assume that a CMPS client is “wholesale” just because they may fall into that category for other financial products or services. In the guide FMA states that “Providers should maintain adequate processes, systems and records in relation to identifying wholesale clients”.

Law reform proposals

In our view the systemic risks in the CMPS sector are large. In particular, a few, large, custodians provide underlying CMPSs for hundreds of FSPs, New Zealand investors hold increasingly large quantities of financial products offshore, and Ponzi schemes arise on a fairly regular basis.

The collapse of Lehman brothers in 2008 led to years of litigation in the UK in relation to the ownership and allocation of client money in the UK under equivalent UK law, only concluding in 2017 in the Supreme Court. The UK law was, even at the time, much better developed than New Zealand’s is currently. So the risk of protracted litigation following a failure of a provider is real. In New Zealand customers of the failed derivatives issuer and CMPS provider Halifax New Zealand Limited had to wait over 4 years to receive the first tranche of commingled investor funds, following High Court and Court of Appeal proceedings.

In its October 2023 report “Lessons learned from the Barry Kloogh Ponzi scheme” FMA noted it had sent proposals to reform the CMPS law to the Ministry of Business, Innovation and Employment. As of July 2024 there is no sign of action to implement those proposals. FMA’s Kloogh report was issued 4½ years after the Ponzi scheme was identified by FMA and 3 years after Kloogh was jailed for his crimes. The Ross and Kloogh Ponzi schemes were not the only Ponzi schemes operated by FSPs identified in New Zealand in recent years.

Cygnus Law has advocated since 2016 for reform to address shortcomings in the regulation of CMPSs. The International Monetary Fund recommended the licensing of custodians in its 2017 Financial System Stability Assessment report on New Zealand.

Despite all of those factors, the regulatory regime for CMPSs in New Zealand is still, in our view, relatively light and underdeveloped. Change appears glacial. FMA’s guide is helpful but is not a substitute for a more effective regulatory regime. The need for licensing seems clear to us. However, significant attention and resource has been focused on further regulation and licensing of already heavily regulated banks and insurers via the “conduct of financial institutions” regime that comes into force next year.

The Kloogh report states that “History shows that such fraud is difficult to detect”. Rather, in our view, history has shown that regulators have failed to put sufficient resource into detecting such fraud. And fraud is not the only risk. Failure of provider systems (particularly those operated by systemically important custodians) is also a risk.

In practice banks are very cautious about opening client money trust accounts for FSPs, because of concerns about anti-money laundering compliance. So this acts as a significant barrier to entry for many FSPs that need to operate a client money trust accounts as part of their businesses. This is another area that would likely benefit from improved law and a licensing regime for providers.

The Financial Markets Authority (“FMA“) has released a proposed guide to “Fair outcomes for consumers and markets” (“guide“). The guide includes 7 “fair outcomes”. FMA plans that the fair outcomes will be the primary guide to its approach to regulation of New Zealand’s financial markets and financial service providers (“FSPs“) in particular. FMA invited submissions on the guide. Cygnus Law’s submission is HERE. A summary of that submission is below.

The essence of the guide is that FSPs are required to treat consumers “fairly”. The guide assumes that what “fair” means is always clear, stating that “We all know what is fair when we see it”. We acknowledge “fairness” is an important concept. However, we don’t consider that “fair outcomes” are an appropriate tool in some areas to guide FMA’s approach to its role. In our view the guide is seeking to impose the fair outcomes as de facto legal standards. We don’t consider that is permitted by law. We propose that the guide should be updated to make it clear that the fair outcomes are aspirational goals and not mandatory requirements, where they are not linked to existing law. If the outcomes are linked to existing laws then the relevant laws should be stated in the guide, to support FSPs to much better understand the function of the fair outcomes.

We do not consider that the “access” section described in the “Consumers have access to appropriate products and services that meet their needs” fair outcome is appropriate.  This seeks to give FMA the ability to intervene in what products and services FSPs provide.  However, no part of financial markets law mandates what products and services should be provided by FSPs.  Rather the law regulates financial products and services that are actually offered to, or purchased by, consumers.  We do not consider that FMA is configured to regulate the financial products and services that should be provided or that it is appropriate to attempt to do so.

We can see no basis whatsoever for the “Consumers receive fair value for money” fair outcome except in relation to misleading and deceptive pricing and KiwiSaver fees.  It essentially seeks to mandate that FSPs set “fair prices”. The fact that the guide attempts to avoid that term via equivalent concepts such as “equity in exchange of value” does not change the essence of what FMA is seeking to achieve. In most areas of law that FMA regulates price setting is not a matter within FMA’s ambit. Price setting and price discovery are a core function of markets. History is littered with examples of misguided and counterproductive attempts to regulate market prices. FMA has provided no cogent validation as to why it is necessary for FMA to get involved in the setting of prices and how that would actually lead to better market outcomes.

The guide does not properly acknowledge the existence and role of other market participants including financial advice providers. By failing to properly acknowledge that the guide will weaken markets, if implemented as proposed. We consider it crucial that the guide acknowledges the important role the financial advice sector plays in financial markets. As part of that a fair outcome should include supporting the growth of the sector and the ability of consumers to get access to financial advice. Our view is that the “Consumers can trust providers to act in their interests” fair outcome should be focused on consumers. It should state as a goal that consumers have access to advice, information and education that helps to improve their financial literacy, decision making and financial outcomes.

We consider that mandating fair outcomes in the manner proposed is not conducive to supporting or encouraging innovation. The imposition of regulation often (but not always) stifles innovation rather than increasing it. The fair outcomes guide is, in effect, another form of regulation. It will further burden FSPs, who have faced a wave of regulation in recent years.  Multiple FSPs have stated new regulations have taken up resources and management time that would otherwise have been focused on other areas including innovation.

FMA has not provided any form of cost/benefit analysis to validate its approach in the guide, which we’d usually expect to see in any initiative to develop de facto legal standards of similar breadth and ambition. We consider that there’s a very real risk that this initiative will impose costs on thousands of FSPs, many of which are already highly regulated, that will exceed the value of resulting benefits to consumers. Those costs will ultimately be borne by consumers.

 

The National, ACT and New Zealand First parties today confirmed their coalition agreements that will form the basis for a coalition of the three parties in Government.  I confirm below the policies in the agreements that impact on the financial services sector and its regulation.  There are two complementary agreements, one between National and Act and one between National and New Zealand First.

Key Policies

Three significant National Party policies that impact on the financial services sector (which I described here) appear to be confirmed in the agreements (directly or indirectly).  Those policies are:

The coalition agreements confirm National’s existing policies (so that includes the three policies noted above) by reference to key National policy documents.  The agreements then set out a series of “exemptions”, which are comprised of variations to or removals of those National policies, and additional policies.  With respect to the three policies, only one is named in the agreements, being the CCCFA policy (as this overlaps with ACT policy).  There is nothing in the agreements to indicate that the other two National policies are not going to be advanced.  However, the proposal to reform the CoFI law might be captured under the requirement in the coalition agreement with ACT to “carry out regulation sector reviews”.  One of the sectors noted as being likely to be reviewed is the “finance sector”.  In each case a review would result in “an omnibus bill for regulatory reform of laws affecting the sector”.  There is nothing to suggest that the coalition partners would be bound to pass such bills into law.  It’s possible that the CoFI law may stand but with changes to introduced in the medium term via the review process.  ACT has a policy of introducing improvements to AML/CFT law so that’s likely to be covered as well.

What is very clear is that there is unlikely to be any significant extension of financial services regulation under the new coalition Government subject to the outcomes of the market study and the select committee inquiry (see below under “Other Policies”).  Current proposed reforms to insurance law are well advanced.  These may be passed but possibly with some changes to reflect the policy priorities of the coalition.

Timeframe

At this stage, it is not possible to determine exactly what will happen in those areas and when.  Given the ambitious agenda of the coalition and that those laws aren’t particularly prominent to the public, they may not be a high priority.

Minister Appointed

Andrew Bayly has been confirmed as the incoming Minister of Commerce and Consumer Affairs.  That Ministry has responsibility for the laws that govern the three National policies.  Bayly appears to have been the key driver of National’s policies in relation to KiwiSaver, CCCFA and CoFI so it’s quite possible he will push those policies forward as Minister.

CCCFA Policy

The ACT coalition agreement states that the parties will “Rewrite the Credit Contracts and Consumer Finance Act 2003 to protect vulnerable consumers without unnecessarily limiting access to credit.”  That aligns with National’s existing policy.  There is no further information but reforms will likely, at the very least, reduce the extent of financial disclosure required and/or reduce the level of verification required.  I expect that most of the comprehensive regulatory regime under CCCFA will be retained but it may possibly be considered under ACT’s regulatory review process.

Other Policies

Many other coalition policies affect businesses in various ways but there is only one other policy that specifically relates to the financial services sector and its regulation.  That is the Zealand First policy that the parties will “Establish a select committee inquiry into banking competition with broad and deep criteria to focus on competitiveness, customer services, and profitability.”  This would overlap significantly with the current Commerce Commission market study into competition in relation to personal banking services, although the focus may be a bit different.  It would seem to make sense for the market study to be completed before the select committee starts its inquiry, as the market study is likely to provide important information on potential problem areas.  This may also overlap to some degree with two agreed ACT policies.  One policy being to reform market studies law “to focus on reducing regulatory barriers to new entrants to drive competition.”  I assume that the current market study will not be impacted by that but that will be confirmed in due course.  The other policy being to carry out “regulation sector reviews”.

On 17 August 2023 at the Financial Services Council New Zealand conference National Party leader Christopher Luxon announced three significant policies relating to investments, insurance and lending. These will be enacted if National forms a government after October’s election (subject to coalition partner agreement). The policies are listed below. [UPDATE- A coalition Government to be lead by the National Party was announced on 24 November 2023. See here for our view on the status of the policies under the coalition.]

National’s commerce and consumer affairs spokesperson Andrew Bayly indicated that other regulatory measures are also in their sights including AML obligations.

Repealing CoFI law would not only have significant impacts on the financial institutions that have already completed significant work on implementation. This would also:

Even if CoFI law is revoked it’s likely that some financial institutions will still introduce some CoFI-related changes. And, while CoFI will undoubtedly improve outcomes for some consumers, there has always been a risk that the high costs of implementation (and indirect costs including reducing innovation and raising barriers to entry) could outweigh the benefits.

The Commerce Commission (Commission) has continued to take steps to try to reduce the fees consumers pay for using some types of payment methods including credit cards.  In connection with that the Commission published updates in early August 2023 on its inquiries into:

We consider the updates below and the possibility that the Commission will use its powers to further regulate in relation to merchant surcharges.

The Commission has previously provided guidance for merchants on merchant surcharges.  We summarise and comment on that guidance HERE.

The Commission is also concerned about a lack of innovation in relation to bank-to-bank payments.  It is considering whether to introduce regulations that will make it easier for new entrants to access bank-to-bank payment networks.  It has published a paper on this topic and potential actions it could take in response, and is seeking submissions by 25 September 2023.  This blog post doesn’t consider that initiative.

The Commission’s actions in relation to interchange fees and merchant surcharges arise in connection with the Commission’s powers under the Retail Payment System Act 2022 (Act) to impose restrictions and requirements on various parties to retail payment networks including:

The Act and the Commission’s investigations are a response to concerns about the level of charges imposed on consumers for using some types of payment methods, and a lack of transparency that affects the ability of consumers to choose the most appropriate payment methods.

Overall it appears that the Commission is taking a measured approach.  In particular, it is seeking more information and trying to influence conduct rather than seeking to immediately impose further regulation.  However, it is possible that the Commission will use its powers to regulate, if it is not satisfied that its efforts are ultimately leading to lower fees for consumers.

This blog post was written by Simon Papa, Ken Ng and Brandon Lim.  If you have any questions or if you would like advice on any of these matters you are welcome to contact Simon Papa.

* This is summary information only.  It does not cover all relevant matters and is not legal advice.  This blog post takes into account law and guidance as at the date of publication.

Interchange Fees

The only restriction imposed under the Act to date is a cap on the value of “interchange fees” that Visa and Mastercard can charge PSPs for payments made using their credit and debit card networks.  The caps came into force in November 2022.  Similar caps have been implemented in other countries including Australia.

In 2009 some changes were introduced in relation to Visa and Mastercard interchange fees together with the removal of contractual bars on merchants imposing surcharges for use of their cards.  This followed the entry into settlement agreements between the Commission and Visa, Mastercard and some banks and merchants.  The Commission considered that the bars on surcharges were potentially anti-competitive.  This highlights that the Commission is not concerned about merchant surcharges being imposed (in fact it supports them as part of price transparency) but rather about the amount being charged.

Interchange fees are the biggest component of service fees PSPs charge merchants for payments made using Visa and Mastercard credit and debit card networks.  So a reduction in the interchange fee should result in a reduction of the service fees PSPs charge merchants.  In its 8 August 2023 update the Commission noted that it was concerned that a significant proportion of cost savings to the PSPs from the lower interchange fees are not being passed on to merchants in the form of lower service fees and ultimately to consumers in the form of lower merchant surcharges.  Also, the Commission noted that, after an initial 8 to 18% decrease in service fees, from December 2022 to March 2023 the average PSP service fee charged to merchants actually increased.  The Commission identified some of the factors that led to the increase including that fees (excluding the interchange fees) are increasing.

It is possible that the Commission will use the Act to address its concerns, if there isn’t further improvement.  That does not necessarily mean that it will seek to further regulate interchange fees.  Rather, for example, it could require standardisation of how PSP service fees are categorised and/or described, so that merchants can more easily compare fees charged by different PSPs.

Merchant Surcharges

On 3 August 2023 the Commission published a progress update on its investigation into merchant surcharges imposed on customers for using some payment methods.  There is currently no specific law that regulates or prohibits merchant surcharges (although poor conduct in relation to payments and pricing could potentially breach fair trading law).  The Commission has the power under the Act to regulate those surcharges.  However, it has not done so as at the date of this blog post.  Its ongoing investigation is clearly part of a process of considering whether it should regulate those surcharges.  The Commission has encouraged merchants to review their approach to surcharging and has published related guidance.  We have summarised and commented on that guidance HERE.

The Commission’s view is that surcharges are acceptable but that they should not, in most cases, exceed the value of the service fees charged by PSPs to merchants for using relevant payment methods.  The Commission is particularly concerned where merchant surcharges include a profit margin.  This follows from the purpose of the Commission’s regulatory powers (stated in the Act) in relation to merchant surcharges, which is to ensure that merchant surcharges are no more than the cost to the merchant of accepting payments.

The Commission notes in the progress update that it engaged with selected large merchants on surcharges, including Air New Zealand, Jetstar, Auckland Council and One New Zealand.  Some have reduced their surcharges as a result.  In cases where the merchant surcharges may be higher than the fees imposed by PSPs the Commission records the status of its inquiries with the relevant merchants as “engagement in progress”. This indicates that the Commission is not satisfied with the initial response from the relevant merchants.

The Commission is encouraging payment terminal providers to monitor whether their terminals are enabling excessive surcharging.

 

Significant changes to parts of New Zealand’s AML/CFT law under the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (Act) have been confirmed. These changes will be implemented progressively with effect from 31 July 2023, 1 June 2024 and 1 June 2025. We explain key changes below by implementation date. The changes mostly either clarify some requirements or add to the obligations of businesses already subject to the Act (called “reporting entities”). Also, some businesses will be brought within the scope of the Act for the first time including some types of virtual asset service providers. The changes are being implemented through amendments to AML/CFT regulations. All existing reporting entities will need to update their AML/CFT compliance programmes (and, in some cases, risk assessments) as a result of the changes.

The changes follow a Ministry of Justice (MoJ) review of the Act. An additional 12 changes proposed by MoJ during earlier consultation are not going ahead at this stage because they can only be implemented through amendments to the Act (the confirmed changes are being implemented through amendment regulations). It is possible that this may occur at a later date. The deferred changes include two that have the most potential to significantly benefit a wide range of reporting entities, being a relaxation of requirements in relation to address verification, and enhanced customer due diligence (CDD) on trust customers. We consider those two changes at the end of this blog.

If you have any questions or if would like advice on any of these matters please contact Simon Papa.

This blog is in the following parts:

+ Changes coming into force on 31 July 2023

+ Changes coming into force on 1 June 2024

+ Changes coming into force on 1 June 2025

+ Key changes removed from draft regulations

This is summary information only, does not cover all changes and is not legal advice. This information takes into account AML/CFT law (including amendment regulations) as at the date of this post.

Changes coming into force on 31 July 2023

Clarification of the definition of “beneficial owner” (in force from 31 July 2023)

The definition of “beneficial owner” in the Act is being extended to include “a person with ultimate ownership or control, whether directly or indirectly” (the high-level definition used internationally). The existing definition in the Act has been recognised as being inadequate and the AML/CFT Supervisors have interpreted the existing definition to be somewhat consistent with that extended definition. So this change may not significantly impact on how reporting entities approach identifying beneficial owners. However, reporting entities should update their programmes to reflect that change.

The changes also clarify that “a person on whose behalf a transaction is conducted” is only a beneficial owner if the individual is “a person with ultimate ownership or control, whether directly or indirectly”. This is a helpful change. It means that current exemptions that address the consequences of the current wide term “a person on whose behalf a transaction is conducted” are either being removed (exemptions in respect of specified trust accounts or client funds accounts) or limited in their application (the class exemptions for managing intermediaries). Reporting entities that currently rely on such exemptions will need to carefully consider the impact of these changes and update their programmes accordingly.

Clarification of the definition of “nominee director” (in force from 31 July 2023)

Since July 2021 reporting entities have been required to check whether company customers have any “nominee directors”. The changes help to clarify that a nominee director excludes a director that is required or accustomed to follow the directions of a holding company or appointing shareholder. This recognises that this is a very common arrangement and not one likely to be designed to facilitate money laundering or terrorism financing.

Additional “legal arrangements” added (in force from 31 July 2023)

The current definition of “legal arrangements” in section 5 of the Act covers trusts, partnerships, and charitable entities only. The changes add additional types of “arrangements” being unincorporated society, fiducie, truehand and fideicomiso. The expanded definition of “legal arrangement” means that some services provided with respect to such arrangements by lawyers, accountants and other businesses will be brought within the scope of the Act. This change is also relevant to the new obligation to obtain additional CDD information about a customer that is a “legal arrangement” (coming into force on 1 June 2024, see below). This applies to all reporting entities.

Clarification of the meaning of “countries with insufficient AML/CFT systems or measures” (in force from 31 July 2023)

The Act requires that:

“countries with insufficient AML/CFT systems or measures in place” (without further defining what that means). The changes state that the term “countries with insufficient AML/CFT systems or measures in place” includes countries that have been identified by the FATF [Financial Action Task Force] as high-risk jurisdictions subject to a “Call to Action” (also known as the “black list”). While this provides some clarity, this is not an inclusive definition so additional countries may be captured also.

Expansion of “stored value instruments” definition and exclusion (in force from 31 July 2023)

The Act applies to providers and managers of various types of stored value instruments (e.g. prepaid cards, gift cards, vouchers). There is an exemption from the Act for services provided in respect of defined “stored value instruments” with a value not exceeding $1,000 to $10,000 (depending on the nature of the instrument) during any 12 month period. The current definition of “stored value instruments” requires the instrument to be a “portable device” (implying some form of tangibility) such as a physical gift card or voucher. The changes replace that definition with a definition that is technology neutral. That means that the exemption will apply to some types of digital instruments such as digital gift cards and vouchers, and to some types of online accounts, but not “virtual assets” (see below). The value thresholds noted continue to apply. The changes also clarify the availability of the exemption where stored value instruments are bulk-sold to corporate customers for distribution to multiple different recipients.

The updated definition also has the effect of either bringing some service providers within the scope of the Act, or adding to their obligations, to the extent they are not able to rely on the exemption. For example, this may capture managers of some types of digital instruments.

Definition of “virtual asset” introduced (in force from 31 July 2023)

A definition of “virtual asset” will be introduced and is related to obligations of virtual asset service providers (see below). “Virtual asset” is defined as “a digital representation of value that can be digitally traded or transferred, and used for payment or investment purposes” but excludes a “digital representation of a fiat currency” (e.g. some types of stored value instruments) and “financial products” (e.g. some types of stable-coins). So “virtual asset” will capture some types of cryptocurrencies, NFTs and other digital assets.

Act to apply to providers of virtual asset safekeeping & administration services (in force from 31 July 2023)

The Act does not currently apply to service providers that only provide the service of safekeeping or administration of virtual assets. The changes will bring providers of such services within the scope of the Act.

Exemption for corporate trustees & nominee companies that are subsidiaries of reporting entities (in force from 31 July 2023)

The changes exempt corporate trustees, and nominee companies, that are subsidiaries of (or that are controlled by) New Zealand reporting entities. This is particularly relevant to law firms and accounting firms. To qualify for the exemption, the subsidiary must provide the relevant services on behalf of the firm, and the firm’s programme must cover the activities of the subsidiary.

Clarification of CDD requirements for designated non-financial businesses or professions (in force from 31 July 2023)

The changes clarify some obligations of designated non-financial businesses or professions (DNFBPs) (e.g. law firms & accounting firms) with respect to CDD.

A DNFBP will not, for new engagements with existing customers, be required to obtain or verify information or documents that have previously been obtained and verified, unless there are reasonable grounds to doubt the adequacy or veracity of the previously obtained information or documents, or if the DNFBP considers that the level of the risk involved requires a fresh CDD. Arguably this was already permitted but this provides helpful clarification.

A DNFBP will be able to conduct delayed CDD when an engagement transitions from a non-captured activity to a captured activity. This is equivalent to the right to delay CDD that applies when CDD is completed during customer on-boarding. The same conditions apply:

Exemption for registered charities providing small loans (in force from 31 July 2023)

Registered charities will be exempted from the Act with respect to “small loans”, being one or more loans made to a single borrower where the aggregate loan amount does not exceed $6,000. The exemption only applies if the borrower is prohibited from repaying in cash.

Prohibitions on certain cash transactions (in force from 11 May 2023)

The following change is already in force as at the date of this blog and was introduced via an unrelated amendment to the Act and associated regulations. However, it is significant for some types of businesses so we note it here. From 11 May 2023 all businesses are prohibited from buying or selling any of the following items where there is a cash payment(s) of $10,000 or more (payments by cheque are also captured):

One effect of this prohibition is that some “high value dealers” are no longer subject to the Act.

CHANGES COMING INTO FORCE ON 1 JUNE 2024

Additional information to be collected when carrying out CDD on customers (in force from 1 June 2024)

Additional CDD information is required to be collected with respect to a customer that is a “legal person” (e.g. a company, an incorporated society) or a “legal arrangement” (e.g. a trust, partnership, charity, unincorporated society), being information about:

The changes require reporting entities to verify that information- the level of verification required will be based on the assessed risk.

While not previously expressly required, it is possible that some of this information is already required to be collected. However, we recommend that reporting entities review their programmes to check whether changes are required to ensure that that information is collected.

Additional information to be collected when carrying out enhanced customer due diligence (in force from 1 June 2024)

Reporting entities will have to obtain additional information when conducting enhanced CDD. Currently, for most types of enhanced CDD, the main requirement is to collect (and verify) information relating to the source of wealth or funds of a customer. The changes will require reporting entities to consider whether to do the following:

We don’t consider it will be necessary to apply all of those measures in every case. Rather we suggest developing policies and procedures to help to identify when such measures are necessary.

Additional requirements when relying on CDD conducted by other reporting entities (in force from 1 June 2024)

The Act allows a reporting entity to rely on another unrelated reporting entity (that is not an agent of the reporting entity) (the “third party”) to conduct CDD. The changes mean that a reporting entity engaging the third party will have to take steps to satisfy itself that the third party has record keeping measures in place, and will make verification information available as soon as practicable on request (and within five working days in all cases). In addition, if the third party is overseas, then the reporting entity must consider the level of risk associated with relying on the third party.

Clarification of obligations with respect to ongoing CDD information and account monitoring (in force from 1 June 2024)

Currently, reporting entities are required to review CDD information when undertaking ongoing CDD and account monitoring. However, there is no express requirement to:

The changes require that those matters are addressed, based on the level of risk. We expect that some reporting entities already do this.

The changes also clarify what “account monitoring” means for DNFBPs (e.g. law firms & accounting firms). MoJ’s interpretation is that “account monitoring” currently means monitoring of “financial transactions” only (which is more relevant for financial institutions rather than DNFBPs). The changes will require DNFBPs to regularly review non-financial activities of the customers when conducting ongoing CDD and account monitoring.

Clarification of record keeping obligations (in force from 1 June 2024)

The Act does not set out how long reporting entities should retain prescribed transaction reports, account files, business correspondence and written findings. The updates require reporting entities to keep those records for 5 years.

Extension of obligations of virtual asset service providers (in force from 1 June 2024)

Some virtual asset service providers (VASPs) are currently captured by the Act (and from 31 July 2023 some new types of VASPs are brought within the scope of the Act- see above).

The changes extend VASPs’ obligations in relation to wire transfers (including to collect and verify certain information in relation to the transfers) and prescribed transaction reporting (PTR) (including to report certain international transfers to the Financial Intelligence Unit at the Police). The changes include:

Additional measures to mitigate the risks of new technologies (in force from 1 June 2024)

Reporting entities are currently required to conduct a risk assessment of their operations, products, and delivery methods. However, there is no express requirement to conduct risk assessments (and to implement appropriate mitigation measures) before launching new technology or new products. The changes require reporting entities to conduct a risk assessment before implementing a new technology or product (including its delivery mechanism). Arguably this is required currently but we suggest that reporting entities update their programmes and risk assessment to take this requirement into account.

Additional obligations in relation to prescribed transaction reporting (in force from 1 June 2024)

There are several changes designed to enhance transparency in relation to international wire transfers (including virtual asset transfers). The changes include requirements to:

Requirement to provide more information about agents in programmes (in force from 1 June 2024)

A reporting entity that uses agents to support its AML/CFT activities will be required to set out in its programme additional procedures, policies, and controls relating to:

Requirement to document when source of funds or source of wealth checks (or both) will be used (in force from 1 June 2024)

A reporting entity will have to state in its programme in what circumstances source of wealth or source of funds checks are required, or both. However, the Act does not explain the distinction and the updated regulations do not provide any guidance on that. Hopefully the AML/CFT Supervisors will provide guidance on this requirement to the thousands of reporting entities that need to implement it.

Requirement to conduct CDD with respect to a low value transaction where there is a suspicious activity (in force from 1 June 2024)

There is no requirement currently to conduct CDD on a person seeking to conduct transactions outside of a business relationship that fall below the “prescribed thresholds”. The prescribed thresholds are $10,000 for cash transactions and $1,000 for wire transfers. The changes will require reporting entities to conduct CDD even where those transactions are below the prescribed thresholds, where there are grounds to report a suspicious activity.

Requirement for MVTS providers to provide SARs to overseas financial intelligence units (in force from 1 June 2024)

A money or value transfer service (MVTS) provider that acts as either the ordering or beneficiary institution of a wire transfer outside New Zealand will have to provide a copy of a suspicious activity report (SAR) to the Financial Intelligence Units in affected countries, if it is required to file a SAR in New Zealand.

All MVTS providers, including informal remittance service providers, subject to wire transfer obligations (in force from 1 June 2024)

The MoJ considers that the current definition of “wire transfer” in the Act does not accurately reflect the technical, legal, and practical realities of how wire transfers are conducted, making it difficult for some reporting entities to comply, especially money value or transfer service (MVTS) providers using informal remittance systems. The updated regulations state that “To avoid doubt… an operator of a [MVTS] must comply with all requirements of the Act and any regulations made under the Act relating to a wire transfer”. This does not materially address any of the issues identified by MoJ so we consider that this provides little (if any) assistance to MVTS providers.

In addition, if a MVTS provider uses an agent (or sub-agent) in relation to a wire transfer, the originator or beneficiary of the wire transfer is deemed to be the “customer” for the purposes of the Act, and not the agent or sub-agent. This is a helpful clarification.

Clarification of intermediary institutions’ exemption from prescribed transaction reporting obligations (in force from 1 June 2024)

“Intermediary institutions” in relation to wire transfers are currently exempted from filing prescribed transaction reports (reports about international wire transfers) (under section 48A of the Act). The changes mean that that exemption will cease to apply to a MVTS provider unless the MVTS provider is a registered bank. This is particularly relevant to some virtual asset service providers that only function as an intermediary institution between the sender and recipient.

CHANGES COMING INTO FORCE ON 1 JUNE 2025

Requirement to conduct customer-specific risk assessment (in force from 1 June 2025)

Reporting entities will have to risk-rate each customer when completing CDD, and to update such risk rating as part of ongoing CDD and account monitoring during the business relationship.

Such risk ratings are arguably already required by implication. Customer risk ratings are likely to be relevant in areas such as determining whether or not enhanced CDD is required on the basis of risk (section 22(1)(d) of the Act), how often ongoing CDD is conducted and whether or not electronic identity verification is appropriate.

Online auction provider exemption narrowed (in force from 1 June 2025)

The current full exemption from the Act for providers of some types of online auction services (e.g. TradeMe) will be considerably narrowed (reflecting MoJ concerns about the risk of trade-based money laundering). The exemption will only apply in relation to a customer where the value of that customer’s transactions do not exceed $10,000 in a consecutive 12-month period. Obligations in relation to suspicious activity reporting will apply with respect to all customers including those who are otherwise subject to the exemption.

KEY CHANGES REMOVED FROM DRAFT REGULATIONS

Simplification of address verification

Reporting entities are required to take reasonable steps to verify that address information they obtain from individuals during CDD is “correct” (interpreted by the AML/CFT Supervisors as verifying that the stated address is where the individual currently resides). In doing that reporting entities must rely on documents, data or information issued by a “reliable and independent source” (for example obtaining utility bills or bank statements sent to the individual).

Draft regulations provided for a narrower obligation, which was to verify that the relevant residential address is “correct”, except where enhanced CDD is required. So it would only be necessary in those cases to verify if an address is “genuine”. We consider that the proposed exemption was fully justified (and in fact does not go far enough), given that address verification provides very limited value (relative to the effort required), is relatively easy to circumvent and can make it quite difficult (or impossible) for some types of people to validate their residential addresses (and therefore to access even basic banking services) including working holiday makers and students.

Requirement to verify source of wealth or funds for low-risk trusts lessened

It is currently mandatory to conduct enhanced CDD on all customers that are trusts and other “vehicles for holding personal assets” regardless of the nature of the trust or the risk the trust poses. Draft regulations provided an exemption from the obligation to verify the source of wealth or source of funds for certain “lower-risk” trusts subject to details to have been included in later regulations. This did not change the requirement to collect such information (which can be a complex undertaking in some cases). So the proposed change was a limited concession in any case. It is disappointing that a more significant relaxation of the law was not proposed, given the costs this requirement imposes (relative to the benefits) and that the Financial Action Task Force (the international body that sets relevant standards) does not mandate that enhanced CDD must be performed on all customers that are trusts.

From 15 March 2021 New Zealand financial advice providers (FAPs) and their financial advisers have new disclosure obligations. Those obligations apply before they engage with retail clients and during the process of providing financial advice to retail clients. Cygnus Law’s Guide to Financial Advice Service Disclosure  summarises the new disclosure obligations and provides guidance on how to apply them. The guide considers disclosure obligations of FAPs that engage financial advisers to give financial advice.

The new disclosure obligations replace requirements to provide static & inflexible disclosure documents under the Financial Advisers Act. Under the new disclosure regime there are no mandated disclosure documents- there is significant flexibility with respect to how disclosure is made. This supports FAPs & their advisers to implement disclosure in a way that ensures clients are best able to engage with the information provided.

Under the new disclosure regime information must be disclosed in relation to the following matters (with some differences at each disclosure stage):

Disclosure is required at four stages:

Cygnus Law can advise you on your specific disclosure obligations and on how to implement them. Contact Simon Papa on 022 644 7193 or at simon@cygnus.local.

In an important test case (Dodds v Southern Response Earthquake Services Ltd) the High Court ruled in August 2019 that government-owned insurer Southern Response engaged in misleading & deceptive conduct, and contractual misrepresentation. The case related to Karl and Alison Dodds’ entitlements under their AMI insurance policy, for which Southern Response is responsible. The Government has confirmed that it will appeal the decision and has offered to pay the Dodds’ legal costs to date and for the appeal. There is a clear incentive to appeal. Media reports indicate that, if the decision is not overturned, the Government may be liable for claims worth hundreds of millions of dollars from thousands of other insureds in the same position as the Dodds.

I summarise the background, and key aspects of the judgment, below. I also consider potential implications of the Government’s response for proposed new conduct law, and key lessons that businesses can draw from the case, regardless of the final decision.

This blog post was written jointly with Cygnus Law Legal Adviser Ken Ng.

Implications for Conduct Law Reform

Later claimants were able to recover the amounts the Dodds are claiming under the same AMI policy as the Dodds, following a Supreme Court ruling against Southern Response (Southern Response Earthquake Services Limited v Avonside Holdings Limited). What makes the Dodds’ case problematic is that Southern Response is continuing to argue that the Dodds are bound by the “full and final” settlement they reached with Southern Response before the Supreme Court decision confirmed the correct interpretation of the policy. While it seems rational for the Government to seek to overturn the decision in the Dodds’ case, in doing so it is sending inconsistent signals about how insurers should conduct themselves.

The Government has raised concerns about poor bank & insurer conduct. As a result the Government recently proposed law reforms to force improvements in insurer and bank conduct. Rob Everett, the Chief Executive of the Financial Markets Authority, in his speech at the Financial Services Council conference on 11 September 2019, stated that:

 Our end goal, and I believe yours is too, is the fair treatment of customers. I can’t emphasise enough that the industry should be choosing to do this, rather than being made to do this.

Yet, in the Dodds’ case, the Government is seeking to rely on strict legal rights against consumers even though fairness clearly indicates that Southern Response should be complying with the judgment. Without the bailout the Dodds would likely have received much less under the policy. However, the Government agreed to underwrite the claims under the AMI policies and so placed itself in the same position as any other insurer. In appealing the decision the Government risks undermining the push the Government, and its agencies, are making to improve bank and insurer conduct.

Background

Following a government bailout Southern Response assumed responsibility and liability for AMI’s policies for claims arising from the 2010/2011 Canterbury earthquakes. It has been reported that the bailout has cost taxpayers about $1.5 billion to date.

In 2011 the Dodds made a claim under their policy for their house, which was damaged beyond economic repair. The policy provided “full replacement cover”. Policy options included having a replacement house built on the same or different site, or receiving a payment to buy another house. The policy stated that payment under the “buy another house option” could not exceed the cost of rebuilding on the existing site. Southern Response obtained a report on the cost of rebuilding the Dodds’ house, which estimated the cost of materials and labour at $895,937. A further section of the report, under the heading “AMI Office Use”, included several additional costings including for internal administration, demolition, design, and project contingency. When these additional costs were factored in the total rebuilding cost on the existing site was $1,186,920.

Southern Response decided that, if the Dodds chose to buy another house, they were not entitled to the additional costs in the “AMI Office Use” section. Southern Response removed the “AMI Office Use” section from the report and sent the abridged version of the report to the Dodds, without telling the Dodds about the removal. Southern Response took the same approach with many other insureds.

The Dodds later entered into a full and final settlement with Southern Response under the ‘‘buy another house option” for the lesser amount in the abridged report. In the Avonside Holdings case against Southern Response, which was decided after the Dodds had settled, the Supreme Court ruled that some of the “AMI Office Use” costs needed to be added to the amount payable under the “buy another house” option. The key question in the Dodds’ case was whether they could overturn their full and final settlement to claim the additional costs the Supreme Court confirmed should be paid.

Decision

The High Court ruled that, by presenting the abridged report as the complete and only estimate document, and by representing the costs in the abridged report as the full cost of rebuilding the house, Southern Response had engaged in contractual misrepresentation, and misleading & deceptive conduct under the Fair Trading Act. The key factor wasn’t that the Dodds didn’t get the extra value, rather that they never got a chance to consider their options.

The High Court ruled that the full and final settlement did not prevent the claims by the Dodds, as settlements induced by misrepresentation, or misleading or deceptive conduct, can be set aside under the relevant statutes. The Dodds are therefore able to claim the costs on the basis set out in the Avonside Holdings case.

The High Court noted that there is a duty on Southern Response, as the insurer, to act with utmost good faith when performing the insurance contract, not just during the formation of the insurance contract. The High Court indicated that Southern Response had not complied with that duty (though that wasn’t relevant to the decision).

Key Lessons for Businesses

Draft Clear Contracts: The Court decisions in the Avonside Holdings case highlight that ambiguous drafting can create significant issues, including lengthy and expensive disputes. It is important that contract terms are carefully considered and clearly drafted, particularly with respect to the key subject matter of the agreement.

Have Effective Risk Management: Southern Response inherited contracts with inherent ambiguities in the meaning of the terms of “full replacement cost” in connection with buying another house. Given the complexities of even a fairly standard house rebuild, the issue of valuation was always likely to arise. Perhaps AMI saw this legal risk as acceptable, to help to ensure the insurance contracts were easy for insureds to understand. However, together with the commercial risk AMI assumed through its overexposure to particular geographic areas, the overall risk profile was significantly higher and tax payers have ended up bearing much of the cost of that risk. This highlights the importance of effective risk management that takes into account cumulative risks.

Draft Settlement Agreements Widely: The High Court found that the settlement agreement itself wasn’t wide enough to exclude the claims made by the Dodds. The agreement only excluded claims arising under the policy and claims arising “directly or indirectly out of the [earthquake] events or any subsequent aftershock”.  The High Court found that the claims arose other than from the policy and earthquakes, including from Southern Response’s misrepresentations and misleading conduct, and its non-disclosure of material information. The High Court acknowledged the possibility that the settlement agreement might have been effective to exclude those claims, if the agreement applied to claims “in connection with” the policy. However, the tone of the judgment suggests that may not have been enough, in practice, to avoid liability for misleading conduct and contractual misrepresentation. This highlights the importance, for parties subject to a claim, of drafting settlement agreements sufficiently widely to also capture “in connection with” claims (though they should take care to avoid engaging in misrepresentation or misleading or deceptive conduct).

ECF

Cygnus Law has published a detailed Guide to Equity Crowdfunding.  In this blog I have included the first section, which explains key aspects of equity crowdfunding in New Zealand.  If you would like to know more see the full guide.  If you would like to discuss please contact Simon Papa (+64 (0)22 644 7193, simon@cygnus.local).

What is Equity Crowdfunding?

Equity crowdfunding (ECF) is about companies that raise capital by offering new shares to investors via NZ-licensed online platforms. ECF provides an opportunity to obtain investment from a large number of investors who invest relatively small amounts.  What sets equity crowdfunding apart from other ways of raising capital is that it is a fairly easy and cost-effective way to offer shares to the general public.

ECF in this form became possible in 2014. Since then dozens of companies have successfully raised capital using ECF through NZ-licensed platforms.

ECF is different from rewards and donations-based crowdfunding, which do not provide for investments. Instead they involve either getting a reward (e.g. a concert ticket, a book) for a financial contribution or simply giving to a good cause.

ECF is just one way that companies can raise capital.  There are many other potential options including funding from founders, angel investors, government grants and bank loans.

Who can equity crowdfund?

Only companies (from NZ and overseas) can equity crowdfund through the NZ-licensed platforms. ECF can be used by companies in a wide range of businesses and of varying sizes. ECF is particularly popular with technology companies and companies with strong consumer brands (e.g. food & beverage businesses).

Can social enterprises equity crowdfund?

Only companies can equity crowdfund via licensed platforms. Directors of NZ companies are mostly required to act in the best interests of shareholders.  Unlike countries such as the United States (with its “B Corporation” regime), there is no form of New Zealand company that can have, as a key goal, providing a public benefit. However, a New Zealand company can legitimately seek to support good causes (e.g. environmental, social) where that forms part of its business model.

Why should I use equity crowdfunding?

The key benefit of ECF is that you get an exemption from the quite stringent legal obligations for public share offers, including those relating to disclosure (there are other exemptions available but they don’t support offers to the general public). This means that it is generally simpler and cheaper to run an ECF campaign, compared to a traditional public share offer. To benefit from the exemption you have to make the offer via a NZ-licensed platform.  ECF can provide other potential benefits, including as a way to:

The platforms themselves can provide added benefit, including because they provide:

The ECF process can have benefits even if you don’t go through with an offer or if the offer isn’t successful. The process of getting investment ready will, in itself, likely help you to focus more on the business’ future, and to prepare the business for its next steps.

How much can I raise using ECF?

A company can raise up to $2m in any 12 month period via ECF on a licensed platform (you may also be able to raise additional capital through other channels at the same time). There are no caps on how much each investor can invest. There are some additional conditions- see the more detailed How much can I raise? section of the Guide for more information.

What are the limitations on equity crowdfunding?

In addition to the $2m cap, there are other specific legal limitations on offers made via ECF, including:

What should I tell potential investors?

You need to provide investors with summary information that presents a “fair view” of the company, the business and your plans for the investment. That information should be presented in a way that’s easy to understand. See the Disclosure to Investors sections of the Guide for more information on what you can and should tell potential investors.

Which platform should I use?

Each platform has a particular market focus, way of operating and special features. It’s best to do research and to talk to the platforms, to see which is the best fit for you. The NZ-licensed platforms are:

Each platform has its own terms & conditions – some common terms & conditions are considered in the What Do Equity Crowdfunding Platforms Do? section of the Guide.

Do I need professional help?

Yes. While ECF is relatively simple (compared to traditional public offers) there are basic things you need to get right, including in relation to issuing new shares and disclosure of financial information. In some cases there may be benefit in getting help with other aspects of an offer e.g. in relation to marketing (including help to produce a video).

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:

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:

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:

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:

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:

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.

The Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (ARC) issued its final report on 4 February 2019.  The ARC’s findings confirm significant and ongoing misconduct by Australian financial service businesses, banks in particular.  The ARC has made wide-ranging recommendations for reform and further action. The ARC did not favour significant changes to regulation but did favour removing a significant number of exceptions that apply in some areas.  The Australian Government has confirmed that it will implement most of the recommendations in full.

In this blog I consider some of the findings and recommendations in the report and their potential impact on law, and regulators, in New Zealand.

The ARC’s findings have already had an impact in New Zealand, through the ARC’s interim report issued in September 2018. Following the report the Reserve Bank of New Zealand (RBNZ) and the Financial Markets Authority (FMA) conducted their own, more limited, inquiries into the conduct & culture of banks and life insurance companies in New Zealand (many of which are owned by the institutions criticised by the ARC). Banks and life insurers are being required to take actions as a result.  So, to a significant degree, the findings and recommendations in the final report of the ARC are already being acted on in New Zealand.  Even before the ARC the FMA was focused on improving conduct and culture, which included investigating and reporting on bank incentive structures in November 2018.

The RBNZ/FMA report on banks did not identify any widespread misconduct of the type identified in Australia by the ARC, but it did identify significant concerns with the banks’ approach to identifying and remediating conduct issues and risks.   The bank sales incentives report identified widespread sales incentives and concluded that the resulting conflicts of interest are not being adequately monitored or controlled.  Significant issues were identified in the conduct and culture of life insurance companies in New Zealand.  The high level of commissions paid to intermediaries was considered to be a significant issue, mirroring the findings of the ARC.  The RBNZ and FMA have proposed areas for law reform and the government has indicated reform will be considered by Parliament next year.

Banks & Life Insurance Companies

The ARC recommends that some types of lawful “hawking” be banned, including the cross-selling of financial products (like superannuation & insurance) 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.  The FMA incentives report did not address cross-selling.  Some banks have already agreed to remove sales incentives for frontline staff.  While a cross-selling ban is possible in New Zealand, it’s probably unlikely in the near term.  A ban will be more likely if other initiatives fail to significantly improve conduct and customer outcomes.

The ARC was highly critical of the conduct of some institutions and highlighted failures in culture and leadership, noting that “Because it is the entities, their boards and senior executives who bear primary responsibility for what has happened, close attention must be given to their culture, their governance and their remuneration practices.”.  It concluded that there was too little focus on regulatory, compliance and conduct risks (with the focus since the global financial crisis being on financial stability), noting that “Too little attention has been given to the evident connections between compensation, incentive and remuneration practices and regulatory, compliance and conduct risks.”  It recommends that APRA (the equivalent of the RBNZ) mandate requirements for bank and insurance company remuneration systems, including placing greater focus on non-financial metrics, such as sound management of conduct risks, and provision for claw-back of payments.  It also recommended that APRA places greater focus on requiring institutions to effectively manage conduct risks and to implement more effective governance.

Culture and governance are key themes considered by the RBNZ and FMA in their reviews.  They have required individual banks and life insurers to improve their governance and management of conduct risks, and have asked them to respond with remediation plans by 31 March 2019 and 30 June 2019 respectively.  RBNZ and FMA have also recommended changes to law, including the imposition of specific conduct obligations on banks and life insurers, which will require them to implement adequate systems and controls for management of conduct risks and potential individual responsibility on senior managers.  These overlap, in broad terms, with the recommendations of the ARC.  However, there is no specific focus on the impact of remuneration on conduct, though that is likely captured by systems and controls generally.  Given the ARC’s significant focus on remuneration I think there’s a possibility New Zealand reforms will impose specific obligations in that regard.

Lenders (including banks)

The ARC didn’t propose any significant changes to the regulation of lenders relevant to New Zealand.  The ARC focused particular attention on the role of mortgage brokers and on bank practices in relation to agricultural lending.  The mortgage broker issues are less relevant in New Zealand, where brokers are already regulated as financial advisers.  While bank practices with respect to agricultural lending have been the subject of criticism in New Zealand, the ARC appeared to respond to more deep-seated concerns about bank conduct in that regard.

New Zealand’s regulatory regime for lending is similar to that in Australia, including the imposition of lender responsibility obligations.  The ARC did not recommend any significant changes to the Australian regime.

The regulation of lenders was reviewed recently in New Zealand and it’s likely that some changes will be made including caps on the value of “pay day lending” (high interest loans), clearer responsible lending obligations and higher penalties.

Insurance Contracts

The ARC proposes some changes to special features of insurance contracts, including to the duty of utmost good faith.  It proposes that insurance contracts be brought into the “unfair contract term” provisions at law.

In New Zealand a review of the century old insurance contract law is underway, which includes a proposal to bring insurance contracts within the scope of unfair contract term provisions in the Fair Trading Act.  The ARC’s view will likely influence the review and final form of reform proposals.

Brokers & Financial Advisers

The ARC pulled no punches over the standard bank and insurance company practice of paying commissions to brokers and financial advisers for products they advise clients to purchase.  The ARC concluded that “conflicts between duty and interest can seldom be managed; self-interest will almost always trump duty”.  It recommends further reducing caps on life insurance commissions and to ultimately reduce them to zero, unless there was a clear justification for retaining commissions.  In the case of mortgage brokers, the recommendation is that the customer pay the fee, which can be added to the loan being acquired.   The Australian government has only committed to further reducing commission caps in some areas but not to removing commissions altogether, subject to review at a later date.  The ARC also recommends that, if an adviser is not “independent, impartial and unbiased”, the adviser must prominently disclose that to the client.  Any adviser who receives a commission will not be independent and will have to make that disclosure.  That is a strong measure but may not, in itself, encourage a move to a fee for service model.  The Australian government has agreed to implement that recommendation.

The RBNZ and FMA observed that high commissions appeared to be driving poor behaviour in the life insurance sector.  In response the government has indicated that it plans to propose caps on commissions.  A number of insurance companies recently announced that they plan to phase-out overseas trips as sales incentives.  It seems inevitable that commission levels will be capped in New Zealand, the only real question being the nature and extent of the caps.  It’s unlikely that bans on commissions will be introduced in the short to medium term.

Financial advice law is in the process of being comprehensively reformed in New Zealand- the new law is likely to be passed in the first half of 2019.  Commission payments were well-debated during the law reform process.  At the time the Government decided against placing any limits on commissions paid to mortgage and insurance advisers and instead focused on other controls including a clients’ interests first duty, disclosure, a code of conduct, and controls on the remuneration banks & insurers pay to staff who provide advice.  The recent proposal to introduce caps on commissions somewhat cuts across the policy basis for those controls.  The proposed reforms are already likely to significantly disrupt the financial advice sector.  A cap on commissions (however formulated) will likely impose further disruption and costs.  However, given the existing momentum for the reforms, I don’t think that there will be any reduction in the conduct obligations in the current draft law.  Consultation on disclosure obligations in 2018 did not propose an obligation to disclose a lack of independence.  I think it’s relatively unlikely that the ARC recommendation to disclose a lack of independence will be adopted in New Zealand.

The ARC report, and the recent report on New Zealand insurance companies, with their significant focus on aspects of adviser conduct, are likely to influence the development of the Financial Advice Code that will apply to all financial advisers and financial advice firms.

Regulators

The ARC was critical of the Australian Securities and Investments Commission (ASIC), finding that “the law has not been obeyed, and has not been enforced effectively.”  It states that “Too often serious breaches of law by large entities have yielded nothing more than a few infringement notices, an enforceable undertaking (EU) not to offend again (with or without an immaterial ‘public benefit payment’) or some agreed form of media release”.  Its recommendations include that ASIC adopt an approach to enforcement that “takes, as its starting point, the question of whether a court should determine the consequences of a contravention” and separation, as much as possible, of enforcement and non-enforcement staff.  In New Zealand regulator conduct has not been reviewed.

The ARC does not propose any significant changes to the “twin peaks” regulatory model in Australia.  New Zealand has a very similar model.  But it recommends that establishment of a body to oversee APRA and ASIC, independent of the Government. That body will assess their effectiveness in discharging their functions and meeting regulatory objectives.

Neither the RBNZ nor FMA have brought material court proceedings against a bank or insurance company.  Like ASIC and other overseas regulators, the RBNZ and FMA have, when it comes to larger institutions, placed significant reliance on enforceable undertakings and other measures not involving litigation (e.g. warnings) in response to misconduct.  In 2017 the IMF recommended that the RBNZ more pro-actively supervise, and take action against, banks and insurance companies.  RBNZ and FMA have stated that the issues identified in New Zealand are less serious than those identified by the ARC, which may make it less likely that proceedings are brought against those institutions.  However, I think the ARC’s conclusions regarding over-reliance on enforceable undertakings and other non-litigation tools may have an influence.  In their reports on the banks and insurance companies the RBNZ and FMA indicated that they were considering the possibility of bringing proceedings.  The reports do not indicate who would be the target of such proceedings.

In November 2017 New Zealand’s Supreme Court ruled unlawful a settlement agreement in relation to criminal proceedings by WorkSafe against the CEO of the Pike River mine (which resulted in a pay out to victims’ families).  The Supreme Court noted that private interests (the interest of the families in a financial settlement) in such circumstances cannot outweigh the public interest in ensuring decisions to prosecute are made lawfully and reasonably in the public interest.  The judgment doesn’t apply to the RBNZ or FMA’s non-criminal proceedings. However, the policy grounds that underlie the decision reflect key policy considerations noted by the ARC, so are relevant to all public bodies considering use of their enforcement powers.

Previous FMA corporate plans indicate that it has put significant effort into improving the effectiveness of its enforcement function.  There may also be an impetus at FMA for greater separation of its enforcement function from its frontline supervision function (to the extent not already separate).  The RBNZ under the leadership of Adrian Orr appears to be taking a more pro-active approach to its role.

I don’t think there will be any changes to the oversight of, or role of, the New Zealand regulators.  A key question is which regulator will be given responsibility for overseeing the proposed new conduct obligations.  Following the ARC approach it would be the RBNZ but it’s possible FMA may be given that mandate.  It’s unlikely that the body proposed by the ARC to oversee APRA and ASIC will be adopted in New Zealand.

FinTechNZ recently published the first detailed New Zealand FinTech ecosystem map–

NZ FinTech ecosystem map

The map highlights the high level of FinTech innovation in New Zealand.  The map covers FinTechNZ members.  This type of map is a valuable way to help to link current and future sector participants and to highlight New Zealand as a tech success story to the world.

FinTech is the combination of financial services with technology to produce new types of financial services and new ways of delivering them.  FinTech is not new, for example New Zealanders were early adopters of payment technology through the EFTPOS system.  But the scale, pace and nature of FinTech innovation has increased greatly in the last ten years.  That has been driven by a number of factors, including access to cheap & powerful computer technology, the internet, smartphones and the availability of investment capital.  In China (and other countries that lack traditional financial services infrastructure) FinTech has become the main mode for delivering retail financial services, through giants such as Alipay and WeChat Pay.

The pace of change is now accelerating in New Zealand.  There are exciting FinTech businesses delivering innovative and accessible financial services to New Zealand consumers and businesses.  Significant innovation is occurring outside of the consumer-focused sector, with large investments being made in “back-end” systems that support existing businesses.  “Regtech” is an example, being technology that supports businesses to comply with ever-expanding regulatory obligations.

A trend overseas is the development of “neobanks”.  Neobanks are online only and provide some key banking services.  They are still at an early stage of development and often don’t have banking licences themselves.  However neobanks present the possibility of significant challenge, in time, to the dominance of traditional banks in core areas such as cheque accounts, credit cards and payments.  There are no neobanks in New Zealand- Volt became the first Australian neobank to obtain a licence in January 2019.

FinTech is accelerating in New Zealand despite the fact that New Zealand innovators don’t have access to the same institutional support & capital available in some comparable countries.  This highlights the very real capability of New Zealand innovators and the high degree of entrepreneurial activity.  However, lack of investment capital in many sectors, beyond that required for fairly early stage growth, is an on-going issue- NZ lacks a significant venture capital base.

A key question is whether regulation is keeping up with & supporting FinTech development (something I’ve commented on before- Regulatory Innovation in FinTech, Law reforms threaten New Zealand financial service exports & NZ FinTech in 2017- make or break?) This can be a difficult area, with support for innovation needing to be balanced against consumer protection.  Positive change is happening in New Zealand including the decision by the FMA last year to approve the provision of “roboadvice” (personalised financial advice delivered online) subject to conditions.  The government is currently encouraging an “open banking” initiative that aims to open up New Zealand’s payments infrastructure to new players.

A draft financial advice code published in October 2018 sets out proposed minimum standards of professional conduct for financial advisers and financial advice firms in New Zealand (it will replace the current code, which applies to a sub-set of financial advisers only).  Cygnus Law supports the code overall but in submissions has proposed a number of potential improvements (Cygnus Law also made submissions on the discussion document that preceded the draft code).

Like similar professional codes, the financial advice code includes standards in relation to ethical behaviour, conduct, client care and adviser qualifications.  The code will come into force in 2020, at the same time as significant new duties at law also come into force.  The new law and the code are primarily aimed at improving customer outcomes, including by:

I’ve proposed as a key area for improvement adding more detail in some of the code standards.  I think that the limited detail in some standards will make it hard for individual advisers and small advice firms to effectively interpret and implement the standards.  I also think that the code should provide more examples of how code standards apply in practice, to help individual advisers and small advice firms to comply.  The draft code only includes two examples, one of which is an example of a bank advice process.

Financial advisers have been particularly focused on the qualification requirements in code standards 9 to 12, which will require all advisers to hold specified qualifications (or their equivalent).  Currently only a minority of advisers are required to hold relevant qualifications.  I haven’t made many submissions on those standards but I have proposed a requirement that advisers complete a specified minimum number of CPD hours annually (instead of the requirement for each individual adviser to decide what an appropriate minimum should be).

The code was published several weeks before the RBNZ and FMA published their report on their review of New Zealand bank conduct and culture.  The review followed interim findings by the Australian Financial Services Royal Commission, which noted concerns about how banks and others use (and misuse) advice processes.  The RBNZ/FMA report states that “To maintain trust and confidence in our financial institutions and systems, banks need to think and act beyond minimum legal and regulatory standards, and champion business models that focus on customer interests.”  I think that the report is a key guide to how the code could be improved.  The report would support changing the example in code standard 4.  That example appears to support the provision of narrow advice to a client, when that does not appear to be in the client’s interest.  I have also proposed that the examples don’t support the use of jargon in client communications, including terms such as “underwriting” and “loading”.

I have proposed other changes to code standard 4, which is intended to support better customer understanding.  An area for improvement is setting out more detailed and extensive requirements in relation to customer on-boarding, for customers’ benefit (and consistent with the RBNZ/FMA report recommendations), including requirements for client agreements:

The Code Working Group will consider all submissions from interested parties and prepare an updated code. It may consult further. The code is expected to be finalised and approved in the first half of 2019. Details of the next steps are set out here.

I’ve repeated below an article I wrote on regulatory innovation in FinTech that was published by FinTechNZ in July 2018.  FinTechNZ is an industry working group that supports and promotes FinTech developments in New Zealand.

FinTechNZ Article

Simon Papa, Director of Cygnus Law discusses the need to develop and maintain effective and flexible regulations that will further support the growth of FinTech in New Zealand.

Regulations are a feature of the financial services landscape and a key consideration (and burden) for FinTech businesses when setting up and operating their businesses. FinTech is, by definition, the application of technology to support and enhance the provision of financial services. It can be helpful to think of law (including regulations) as another type of technology. Law is a human invention that, when well-executed, enables us to achieve efficiencies and goals we wouldn’t otherwise be able to. Looked at in this light, regulations are not external to FinTech, but an integral part of the technology ecosystem.

Of course regulations can enable, and also restrict, the advancement of FinTech. Businesses in the FinTech sector can be disproportionately affected by ineffective regulatory regimes. For example, until recently, some types of robo-advice were prohibited in New Zealand, because of a legal requirement that the advice be provided by humans. The Financial Markets Authority has now removed that requirement, provided certain standards are met by the provider. This is a good example of regulation adapting to meet the needs of the market. It follows that FinTech businesses, to the extent feasible, should actively engage in the process of making and updating regulations, to help to ensure regulations are effective and don’t unnecessarily stifle innovation and business activity.

Services, including financial services, are increasingly traded digitally across borders. So development of regulations that support that trade, while protecting customers and the reputation of regulatory systems themselves, is becoming more important. New Zealand, with its strong institutions and relatively small size, is well-placed to develop and maintain effective and flexible regulations that will further support the growth of FinTech in New Zealand. Effective regulations can also be used to support New Zealand as a place to locate reputable export-orientated FinTech businesses, in order to grow and diversify New Zealand’s export base.

This blog post was first published as an article on the business law website interest.co.nz.

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.

On 16 November 2017 NZ’s Financial Markets Authority published a draft robo-advice exemption notice.  FMA is seeking feedback on the notice and related documents by 15 December 2017.  The exemption notice will be in force by early 2018 and will make it possible to deliver personalised financial advice online using algorithms (currently such advice must be delivered by humans).  A robo-advice service provider can only rely on the exemption if approved by FMA- this requires the provider to meet licence-type standards.

I consider the draft notice and related documents below.  I’ve provided background previously in blogs on the proposed roboadvice exemption and on FMA’s confirmation that it will authorise robo-advice via an exemption.

This is the first time FMA regulation has focused primarily on a technology as opposed to a particular sector or product. This may serve as a template for regulation of other new technologies by FMA, like financial services and products based on block-chain technology.

The Exemption

The notice provides for an exemption from the requirement in the Financial Advisers Act (FAA) that personalised financial advice must be provided by a human.  To rely on the exemption a provider needs to be listed in the exemption itself. To become listed, the provider needs to satisfy FMA that the provider meets the minimum standards set out in the application guide (I discuss that in the next section).

The notice confirms that robo-advice will be permitted in relation to both financial advice and investment planning services (previously it was unclear whether investment planning services would be covered).  An investment planning service designs a financial plan based on a clients’ current and future overall financial situation and investment goals.  This will be helpful for investment-focused robo-advice services, as the dividing line between “financial advice” and “investment planning” is not always clear.

The notice does not exempt providers of discretionary investment management services (DIMS).  This makes sense since investment management does not, in itself, involve providing “advice”.  It’s possible now to provide on-line investment management services, though anyone doing so on a “discretionary” basis for retail clients needs a licence.

The notice confirms FMA’s earlier decision that it won’t impose caps on the value, or wide restrictions on the type, of financial products that a robo-advice service can advise on.  In particular, it permits advice to be provided with respect to a wide range of common financial products (e.g. listed shares, KiwiSaver schemes), general and personal insurance, and consumer credit contracts (e.g. home loans).  The fact that few people are accessing (or able to access) personalised advice on KiwiSaver schemes was a key driver for the exemption.  So it’s likely that services offering advice on KiwiSaver schemes will be developed at an early stage.  Early robo-advice services in relation to KiwiSaver may include SavvyKiwi and scheme providers (with respect to their own schemes only).  Ilumony and Sharsies are examples of existing services in relation to investments generally that may develop  robo-advice services.

While many existing robo-advice services overseas primarily focus on wealth management, more recently robo-advice services have moved into the insurance and home loan sectors, where financial advisers (brokers) are often used.  So other early robo-advice services are likely to be provided by insurance companies and “mortgage brokers”.  Trussle and Habito in the UK are examples of robo-advice in the mortgage broking sector.  Product providers are likely to use robo-advice, but restricted to their own products.

A condition of the exemption is that specified information about the service must be disclosed to customers.  FMA has noted that disclosure is very important but can be adapted in ways that enhance clients’ understanding e.g. by spreading disclosure across different webpages.  Disclosure obligations include specifying the scope of the service- this links to an obligation in the application guide to have ways to “filter” clients for whom the service is not appropriate.  A key change in relation to advice on insurance products and loans will be that detailed information on fees paid by third parties (typically the product providers and banks) to the robo-advice service must be disclosed- currently financial advisers are not required to provide that level of fee disclosure in relation to insurance and loans.

A specific disclosure obligation will be to state that the service “is not endorsed or approved by the Financial Markets Authority”.  However, FMA itself refers to providers under the exemption being “approved” by FMA, and licence-type standards must be met by providers before they will be permitted to offer services under the exemption.

Providers will need to comply with other requirements in the FAA, including to provide services with the required level of care, diligence and skill, and to comply with relevant standards in the Code of Professional Conduct for Financial Advisers (Code).  Relevant Code standards include placing the client’s interests first, managing conflicts of interest, communicating clearly, concisely, effectively, and ensuring clients can make informed decisions about the services.  Providers also need to consider other legal obligations, including anti-money laundering obligations (particularly for investment advice) and broker/custodian obligations (e.g. if the service handles payments for clients).

Application Guide

The application guide follows the format of FMA’s application guides for FMA licences and includes many of the standards set for such licences.  That includes that the directors and senior managers meet “character” and “capability” standards, and that the service meets specified standards in relation to staff, outsourcing, record keeping, IT systems & security, risk management and operational capability.  Some key minimum standards specified for other licence types are absent, in particular those in relation to governance and financial resources.  That will be helpful for start-up and early stage businesses.  However, governance and financial management will still be important. The application guide sets a high bar– providers will need to embed compliance systems, and a compliance culture, within the business from the outset.

The guide focuses in particular on operational capability.  This starts with the senior management team.  While the guide recognises that key parts of the service can be outsourced, it requires senior managers to have the capability to assess outsourced providers and to monitor them, to ensure they provide services to an acceptable standard.

The default expectation is that the service will have at least one authorised financial adviser to help with ensuring the service is compliant.  However, the service doesn’t need to if it can validate that other expertise will ensure the same outcomes can be achieved.

The guide sets out detailed expectations with respect to the technology.  The IT systems must have all functionality necessary to provide the service in compliance with the FAA, the Code and other legal obligations.  FMA states that it expects “rigorous testing and monitoring in the design phase, or after changes to the algorithm”.  FMA acknowledges that what is required will vary significantly depending on the scale and sophistication of the service.  So while robo-advice is based on technology, the overall effect of these requirements is that it may be harder to use a “lean startup”-type process, which relies on rapid product iteration, to develop and operate a robo-advice service.  FMA will need to be satisfied that the provider is capable of providing a compliant service from the outset.

This blog is a brief summary only and should not be relied on as legal advice.

The Financial Markets Authority announced on 18 October 2017 that it will allow full robo-advice to be provided in New Zealand.  That is, it will be possible to deliver personalised financial advice online using algorithms.  FMA is aiming to accept applications for authorisation in early 2018.  FMA is permitting robo-advice under its power to grant exemptions to existing financial advice law, which currently requires any “personalised” financial advice to be provided by a human.  The exemption is being adopted as a stop-gap measure pending a proposed new law, expected to be in place in 2019, that will authorise robo-advice and will require all robo-advice providers (and all other financial advice firms) to hold a licence.  I summarise key features of the exemption below.  The following landscape shows at a high-level the current (complicated) regulatory regime for financial advice services, FMA’s June 2017 robo-advice exemption proposal and the exemption to be adopted.

Regulatory Landscape

NZ Roboadvice Regulation - FMA exemption Oct 17

Background

FMA proposed a roboadvice exemption in June 2017 and sought submissions.  I commented on the exemption, highlighting that it appeared to have many features of a “regulatory sandbox, and outlining Cygnus Law’s submissions on the proposal.  FMA received 49 submissions on the proposed exemption and has responded to some of the concerns raised in those submissions.

Key Features of the Roboadvice Exemption

The exemption to be adopted includes the following key features:

Allowing personalised roboadvice:  Under current law “personalised” financial advice (advice that takes a person’s individual situation into account) must be provided by a human.  The exemption will permit personalised roboadvice to be provided.  That is, it will be possible to deliver personalised financial advice online using algorithms.  This is already permitted in many countries and has led to significant innovations in advice delivery.

All products permitted & no value caps:  FMA had proposed that certain financial products would be excluded from the exemption, for example life insurance and mortgages.  FMA had also proposed caps on the value of financial products that could be advised on.  Those limits and caps won’t be included in the exemption.  FMA’s announcement is silent on financial planning services- FMA had queried whether they should be covered by the exemption.  Given the absence of limits and caps my assumption is that financial planning services will be permitted to be provided via roboadvice – this will be confirmed when the draft exemption is available in November 2017.

Authorisation required:  FMA had proposed a very “light touch” approach to regulation of roboadvice under the exemption, which would have allowed anyone to provide roboadvice provided they met “good character” requirements.  However, the exemption will require applicants to follow a similar process for authorisation as that for “authorised financial advisers” (AFAs).  AFAs are individuals who advise on investments.  So roboadvice providers will need to submit an application for authorisation to FMA, showing that key individuals are of good character and that the provider has the capability and competence to provide roboadvice.  The FMA has declined to require applicants to meet the more exacting licensing standards that apply to “qualifying financial entities” (something Cygnus Law and other submitters had proposed).  FMA will consult on the application process and exemption notice in November 2017.  FMA rejected submissions that the standards under the proposed licensing regime be applied under the exemption, on the basis that FMA cannot bring forward the relevant requirements and that many are still in development.  It’s possible that the exemption will provide for transition to the licence regime under the proposed law.

AFA standards to apply:  FMA had proposed that many elements of the Code of Professional Conduct that applies to AFAs would not apply to a roboadvice service.  FMA appears to have stepped back from that and will require that roboadvice “be delivered in a manner that is consistent with the principles of the Code of Professional Conduct”.

FMA’s roboadvice exemption is a very positive development and will support the development of new and innovative financial advice services that benefit consumers.  The exemption will also bring New Zealand’s financial advice law into line with Australia and other countries with respect to roboadvice.

 

 

 

 

 

 

 

 

 

 

 

New Zealand’s Financial Markets Authority has just published a class designation that is important for all foreign exchange dealers.  It comes into effect on 1 December 2017 and confirms that “forward foreign exchange contracts” are not “derivatives” under the Financial Markets Conduct Act (Act).  I explain the background and significance of the designation below.  The FMA’s report on submissions includes helpful background on the designation.

The starting point is not forward foreign exchange contracts but FMA’s concerns about the activities of issuers of certain types of “short duration derivatives”.  FMA received a significant number of complaints from New Zealanders about high risk short duration derivatives such as FX CFDs and binary options, especially those issued by on-line platforms outside New Zealand.  “Short duration derivatives” in this context are derivatives (contracts where value  is determined at a later date by reference to something else) that are settled within either 1 or 3 working days.  In particular, the definition of “derivative” in the Act excludes “foreign exchange agreements” that settle within 3 working days.  FMA previously considered that all short duration derivatives were exempted from the definition and so a licence was not required to offer them to retail clients.  However, FMA revisited the interpretation following the complaints.  After taking into account the wider definition of “derivative” in the Act and the background of the definition, FMA concluded that certain short duration derivatives (including FX CFDs and binary options) are in fact captured by the wider definition of “derivative”.  As a result issuers of such short duration derivatives to retail clients in New Zealand require a derivatives issuer licence from FMA (even if they are based outside New Zealand).  FMA granted a grace period until 1 December 2017 for issuers to obtain a licence.

A “side effect” of the updated interpretation is that FMA considers that certain deliverable foreign currency transactions that settle within 3 working days (the “forward foreign exchange contracts” defined in the designation), a type of transaction commonly undertaken by foreign exchange dealers for legitimate purposes, are caught as “derivatives”.  Under the previous interpretation a licence was not required to offer such forward foreign exchange contracts to retail clients.  However, under the updated interpretation a licence is required (registered banks don’t require a licence but still obtain benefits from the designation).  The FMA considered that the costs of obtaining a licence in that case outweighed the benefits and, accordingly, used its designation power (a power to, in effect, alter the law) to remove forward foreign exchange contracts from the definition of “derivative”.  The designation comes into effect on 1 December 2017, the date when the grace period ends.

The definition of “forward foreign exchange contract” is based on the definition in the Australian Corporations Act but with some changes.  In particular, the definition requires that the rate of exchange be determined on the date of the contract.  The FMA has also included a definition of “working days” in the designation, consistent with the definition in the Financial Market Conduct Regulations.  That definition takes into account public holidays or bank holidays in other countries in some circumstances.

Cygnus Law can advise you on the implications of the designation as well as of the change of interpretation of “derivative”, and can assist you to obtain an FMA licence, if required.

This blog is a brief summary and for information only and should not be relied on as legal advice

The first successful court proceedings have been brought for breach of NZ’s anti-money laundering (“AML”) law.  The High Court imposed a pecuniary penalty of $5.29m on the company, Ping An Finance (Group) New Zealand Company Ltd (“Ping An”).  Its director was banned from providing financial services.  The proceedings were brought by the Department of Internal Affairs, the relevant regulator.  The case is particularly relevant to NZ businesses subject to AML obligations, as it confirms the interpretation of some key provisions.

Ping An operated a foreign exchange & money remitter business in Auckland.  The Court found that Ping An was “seriously deficient in complying with a multiplicity of obligations under the Act” and that there were “widespread contraventions across several key areas which were not isolated or infrequent”.  The contraventions were clear and included failing to carry out customer due diligence, to keep records and to report suspicious transactions.

The case is significant for being the first time successful court proceedings have been brought for contraventions of NZ’s AML law and for the large pecuniary penalty.  The penalty reflects the seriousness of the breaches, the actions of the director to mislead the investigators and the need for large penalties to effectively achieve the AML law’s objectives.  The judgment also helpfully confirms the interpretation of some key provisions, including:

It would be advisable for businesses subject to AML obligations to review the case and to then consider whether their AML/CFT programme, and related systems and processes, are compliant with those interpretations.  Cygnus Law advises on AML obligations and can assist you to review your programme, systems and processes in light of the judgment.

This blog entry is a brief summary and for information only and should not be relied on as legal advice.

New Zealand’s Financial Markets Authority (FMA) published its first ever corporate plan (CP) in August 2017.  The CP sets out FMA’s planned regulatory activities and key areas for future focus for the period up to July 2018.  This sits alongside other core strategy documents and provides a useful summary of current & future activities, as well as highlighting new initiatives.  I comment on a few interesting parts of the CP below.

The CP includes FMA’s most detailed statement to date on its approach and attitude to innovation, particularly in relation to financial technology (FinTech).  While FMA has certainly been supportive of FinTech it has not made much information available publicly, whereas regulators in other countries have been undertaking significant branded FinTech initiatives.  Key FMA proposals include increasing engagement in the sector, providing tailored guidance material, and reviewing the impact of regulatory burdens on innovation.  The CP is the first FMA publication to refer to the FMA’s “Innovation Strategy Group”, which leads FMA thinking and co-ordination in the area and is chaired by Garth Stanish, FMA’s Director of Capital Markets.  It is also notable that this is the first FMA strategy document to use the term “FinTech”.

The CP is the first FMA strategy document released since the International Monetary Fund (IMF) published in May 2017 the results of its 2016 review of NZ’s financial sector.  FMA sets out in the CP initiatives it is taking to respond to key IMF recommendations.  That includes building a better understanding of wholesale market risks (including wholesale asset management and custody), seeking improvements in the independent supervisor regime, and undertaking policy work to support potential licensing and supervision of custodians (an IMF recommendation).

The CP sets out a new initiative, being a thematic review of incentive structures and conflicts management in vertically integrated firms.  This appears to focus in particular on product providers (e.g. large institutions like banks and insurance companies) who both create financial products and distribute them.  While addressing conflicted conduct is an existing FMA priority, the review is perhaps a response to the complaint of financial advisers that, while the advisers have been the subject of a wide-ranging inquiry by FMA into their insurance replacement activities, potential conduct issues arising from product providers distributing their own financial products have not been specifically addressed.  A thematic review is of a lower order than an inquiry but it may lead to further regulator activity in the future.

The FMA sets out a programme of work to support the proposed change of law that will require (amongst other changes) all financial advice businesses (even very small ones) to hold a license.  FMA’s activities will include mapping out related transitional arrangements and understanding more about the registered financial adviser (RFA) population.  Clarity about FMA’s approach will be helpful, particularly as the law changes are still to be debated in Parliament.  FMA’s approach in this area will hopefully help to limit the potential large regulatory burden that could fall on small advice businesses as a result of licensing.

The CP highlights work FMA is carrying out to improve its own effectiveness and efficiency, in response to a review by Deloitte in 2016.  Key areas of focus include implementing a more intelligence-led approach to FMA’s activities, further embedding a culture of continuous improvement in FMA’s investigations and enforcement areas, and better recording of the resource applied to different sectors.  FMA will report on initiatives to assess, respond to and reduce regulatory burden.  These initiatives are all likely to have longer-term benefits for market participants.

The CP includes a very helpful internal structure diagram showing each function within FMA and key management roles and personnel within each of them (see pages 24-25).  It also shows head counts for key functions.  The largest department is “Supervision” with 28 staff- a challenging role for the manager of that department.  While most of the executive team is comprised of white males, there is much greater diversity amongst the senior managers, in the next tier down.  The CP also highlights that head count is not increasing in proportion with FMA’s significant increase in funding.  The CP notes that this reflects a number of factors that cause a non-linear response.  This is potentially positive, particularly if FMA can make greater use of technology to drive efficiencies and effectiveness in its operations.

Developments in technology and regulation are making it ever easier for FinTech start-ups to challenge (or partner with) stodgy incumbents and to create wholly new service types.  However, FinTech is harder than other start-up sectors, because financial services are heavily regulated.

I’ve assisted FinTech start-ups at Cygnus Law and in my previous role at a regulator (the FMA).  I identify below key attributes I think are shared by successful FinTech start-ups that provide financial products and services to “consumers” (retail customers).  My focus is on factors important to FinTech start-ups in particular, especially regulation, not on things that matter to start-ups generally like investors, technology, minimum viable product, marketing strategies.

You embed legal compliance in everything you do from the beginning.  Legal compliance isn’t just a job for your lawyer or a compliance officer, or something to sort out later.  You and your team should have an in-depth understanding of the law that applies to your business from the beginning.  That not only helps you to comply but will help you to innovate.

You’re diverse.  Diversity is not just about gender and ethnicity – it includes things such as background, skills, experience and personality.  Diversity is even more important in FinTech, which requires a multi-disciplinary approach to successfully deploy products and services and to comply with law.

You take licensing seriously.  If you need a licence to operate your business you should understand the licence requirements in detail at the outset and you need the time and resources to see the process through.  If you think it will be easy to get a licence you haven’t done your homework. See my blog for tips on how to get a licence.

You embrace risk.  Under New Zealand law you cannot contract out of liability to consumers.  So in my view writing detailed terms that attempt to exclude every possible liability is not a constructive use of your (or your lawyer’s) time.  Rather than trying to define risk away, a successful start-up focuses on clearly defining what it is the start-up does (and promotes that) and ensures that it does that well and in compliance with law.

You have a good relationship with the right people at your bank.  If you’re relying on bank accounts to transact with customers, or to hold customers’ money, talk to the bank early and before you spend a lot of time and money on the project.  If the bank makes it sound easy you’re talking to the wrong person or department.  By the way, it’s likely to take months, not weeks, to get the bank accounts & services you need, assuming the bank play balls at all.

You get legal advice.  You can try to do it yourself but in my experience that’s rarely a recipe for success.  I’m not trying to sell my services.  It’s quite common for start-ups to spend a lot of time and money going down the wrong path, which they could have avoided with fairly minimal legal advice early on.  Talking to the regulator will be helpful but a lawyer experienced in your area can provide the kind of frank and practical advice the regulator can’t.

You consider strategic partnerships.  It can help to partner with existing businesses, and with individuals, who have experience in financial services and regulation (if you don’t).  But make sure to do your homework on them and that the cultural fit will work.  And be aware that institutions may take a long time to make decisions (if they make one at all).

You understand that the web isn’t a law-free zone:  If you use a website in New Zealand (or anywhere else) to provide financial products or services to a consumer in another country, the law of that country will likely apply to you.

This blog provides general information only in summary form – it isn’t, and shouldn’t be relied on as, legal advice.

Cygnus Law has made submissions on the FMA’s June 2017 proposal to use its exemption power to permit true “roboadvice” to be provided to consumers in New Zealand.  I’m highly supportive of an exemption and I commend the FMA for taking the initiative to propose it.  The roboadvice exemption is important, including because:

I noted after the proposal was published that it has some attributes of a “regulatory sandbox”.  A regulatory sandbox supports innovative businesses by allowing them to provide financial products and services without having to meet all usual regulatory requirements, with allied restrictions to protect their customers.  While I support the implementation of a formal regulatory sandbox by the FMA my preferred option is that businesses wanting to use the exemption obtain “QFE” status.

FMA’s Roboadvice Proposal

If granted the FMA’s proposed exemption will allow financial service businesses to provide personalised financial advice on a limited range of financial products, such as shares and KiwiSaver schemes, subject to low value caps.  There will be very little regulatory oversight of the new services, including no prior checks on the providers except in relation to “good character”.  I consider that the limitations and caps in the proposal would not fully mitigate the risks presented by the proposed “light touch” approach and would tend to strongly favour services provided by product providers.

Cygnus Law’s Preferred Option  

I think that any business wanting to make use of the roboadvice exemption should be required to obtain, as the key condition, “qualifying financial entity” (QFE) status (or should update an existing status to meet roboadvice service requirements).  A QFE is a business that has obtained a licence by meeting the requirements set out in the QFE Adviser Business Statement Guide.  That guide could be updated to include additional requirements for a business providing a roboadvice service (such as requiring the business to show how it will ensure its algorithms provide compliant advice).  Under that model there would be no mandatory service limits or value caps.  The requirement to obtain (or update) QFE status has a number of benefits:

Regulatory Sandbox

Regulatory sandboxes have been implemented in other countries (including in Australia, Singapore and the UK) to support the development of new and innovative financial services businesses.  However, the FMA’s proposal lacks key controls and support mechanisms that mitigate the risks arising when a regulatory sandbox is implemented.  I support the development of a regulatory sandbox in NZ but only for start-up companies and only after a regulatory sandbox policy has been adopted by the FMA.  I don’t consider that a regulatory sandbox approach is the best way to facilitate provision of personalised roboadvice services generally in New Zealand pending implementation of the new law.  As it is, the sandbox approach reflected in the proposal lacks a number of key additional attributes of sandbox regimes outside New Zealand.  In particular, the Australian regime (as set out in ASIC’s Regulation Guide 257 Testing fintech products and services without holding an AFS or credit licence) has a number of additional attributes that mitigate the risks arising from the sandbox approach:

roboadvice image med.jpg

New Zealand’s Financial Markets Authority (FMA) has proposed a change to law to allow full roboadvice to be provided on some investments and other financial products in NZ. FMA’s proposal, if implemented, appears to create a “regulatory sandbox”.  A regulatory sandbox is an approach to regulation that supports start-up businesses & innovative new services, by allowing financial products and services to be provided without having to meet all usual regulatory requirements, with allied restrictions to protect consumers.  Regulatory sandboxes have been adopted by other countries to nurture the development of new financial technology (“FinTech”) businesses but the FMA has previously expressed scepticism about using them in NZ.

Proposed Exemption

The FMA proposes to use its power to grant general exemptions from the requirements of the Financial Advisers Act (FAA) to (in effect) change the law to permit roboadvice.  The exemption would allow personalised roboadvice to be provided, that is personalised financial advice delivered online using algorithms (the FAA currently requires a human to deliver such advice).  The proposed exemption is a stop-gap measure until Parliament passes planned legislation to reform financial advice law (the Reform Law)- the draft law (and Government policy) supports roboadvice. The Reform Law may not be in force until 2019.

“Financial advice” under the FAA can relate to three categories of “financial products”, investments (shares, managed funds etc), insurance products and loans (including mortgages).  Overseas roboadvice services have primarily focused on investments, but some also advise on products like insurance and mortgages.  Early roboadvice providers focused primarily on investment management, helping clients to enter into (and to manage holdings of) exchange traded funds (“ETFs”), based on some limited inputs, including the client’s risk profile.  The “advice” in roboadvice arose from the fact that, in the United States, investment management is regulated as a “financial advice” service (still the approach in NZ for limited types of “discretionary investment management services”).

The Reform Law will likely require all financial advice firms, including those providing roboadvice, to hold a licence issued by the FMA.  Licensing has become the norm for new categories of financial services (recent examples are equity crowdfunding and P2P lending services).  However, FMA is not proposing that a licence will be required in order to rely on the exemption.  That’s despite there being an existing licence type that could be a pre-condition for use of the exemption, the “Qualifying Financial Entity” (QFE) licence.  So the bar to using the exemption to provide roboadvice will be relatively low- a licence won’t be required (but FMA will first need to confirm that “good character” requirements are met). To address the risks of this approach FMA is proposing some quite strong restrictions and conditions.  The exemption may be limited to relatively simple products that can be easily exited – insurance such as life, health, income protection, and mortgages, are excluded (but FMA is seeking feedback on that class of insurance products, which may be permitted but with relatively low value caps).

The FMA has also asked for feedback on the restrictions and conditions, including on whether:

A Regulatory Sandbox? 

The FMA’s proposed roboadvice exemption has all the hallmarks of a regulatory sandbox- the usual (and anticipated) regulatory barriers to entry are lowered while quite strong restrictions are placed on the services that can be provided to protect consumers.  I think permitting a regulatory sandbox is a good initiative but I query whether FMA should adopt a formal regulatory sandbox policy, so that this approach is considered in other areas where it may be of benefit and to ensure a consistent approach to “sandboxes” across FMA’s regulatory ambit.  I also think there are potential issues with the exemption as proposed by FMA.

Potential Issues

The FMA’s proposed exemption may not allow the full benefits of roboadvice to be realised at this stage:

Also, the FMA’s discussion paper on the exemption doesn’t consider in any detail the potential to use QFE licensing to allow businesses (including start-ups) to use the exemption to advise on “riskier” product types (without caps) and to provide more complex financial advice.  Those businesses may otherwise be forced to apply for costly and time-consuming individual exemptions.

Cygnus Law’s submissions on the proposed exemption will address these and other points.  These comments are not intended to take away from the FMA’s very real achievement in proposing the exemption.  Whatever the final form of the exemption, it will have real benefits.

Cygnus Law has made joint submissions on the FMA’s proposed restrictions on the use of “investment companies” in New Zealand.  The submissions address a number of matters, including restrictions on crowdfunded offers, the impact on non-regulated offers and the importance of certainty.

The proposed designation addresses concerns about the use of companies as investment vehicles for what are, in effect, managed investments.  Retail investors in such companies do not have the level of protection afforded to retail investors in managed investment schemes (even though in economic substance the investments are similar).  The effect of the changes would be to automatically convert companies that meet certain criteria into managed investment schemes.  Triggers for conversion include where shareholders do not have full voting rights (including to appoint a director) and where the company has an entrenched management agreement on terms that are unfavourable to the company.  The consequences of conversion would include a requirement to have a statement of investment policy and objectives (a SIPO) and to appoint a supervisor.

FMA has stated that it intends to issue a designation to address investment companies.  The only questions now relate to the precise terms of that designation.   This will be the FMA’s third use of its designation power.  This power allows FMA to, in effect, change the law, including by converting one type of financial product into another (in this case from shares to managed investment products) and by converting a wholesale offer into a retail offer (which will impose many more regulatory obligations on the offeror).  FMA has a related exemption power, which allows FMA to exempt people and transaction from compliance with parts of financial markets law.

Please note that this blog entry is a broad summary only, is not legal advice and should not be acted or relied upon without seeking legal advice.

Simon Papa

 

 

Fintech.jpg2017 is likely to be a key year for FinTech development globally.  NZ has introduced initiatives to support FinTech but is falling behind other countries in the support it provides.  In my view the NZ government needs to take a more strategic approach to FinTech and the financial services sector generally, if NZ is to gain the full benefits of FinTech innovation.

Key Insights

On 17 January I attended a seminar in London where UK regulators and market participants set out their view on where FinTech is heading in the UK and elsewhere. Key insights from that seminar include:

What does it mean for NZ? 

NZ took some relatively early steps to support FinTech, including by passing fairly permissive equity crowdfunding and P2P lending regulation as part of the broader consolidation and improvement of financial markets law.  The KiwiBank FinTech Accelerator has just started providing support to early stage businesses.  Despite that NZ has not kept fully in touch with FinTech initiatives in countries we often use as bench-marks (I don’t consider the on-going failure of Australia to implement a crowdfunding law is material).  In my view the key issue isn’t a failure to implement one or more FinTech initiatives but the apparent absence of a true strategic approach at government level to FinTech and the financial services sector more broadly.  This was identified in October 2016 by Chapman Tripp, which proposed establishing a FinTech Advisory Group and other measures.  The risk from a failure to take a more strategic approach to this sector is that NZ will not realise the full benefits that FinTech offers.

Should NZ better support FinTech?

Other countries provide greater direct and indirect financial support for FinTech e.g. the crowdfunding sector in the UK is underpinned by investor tax benefits.  Clearly the financial services sector is more important to the economies of those countries (and even mission critical) – that also suggests that they’ve already taken a more effective long-term strategic approach to the sector.  So a key decision for NZ is whether we should provide that type of support for FinTech (film making, a relatively recent service sector export champion, is underpinned by tax breaks).

Does NZ need an export orientated financial services sector? 

A broader strategic question is whether NZ wants (and needs) an export orientated financial services sector.  We don’t have one currently but in the internet age it is possible.  Supporting FinTech may have relatively little benefit (beyond improvements in efficiency and service in the domestic market) if NZ FinTech start-ups move to countries that are more supportive of FinTech, in order to grow (and to access capital).  There are obvious risks for small countries operating in that sector (Ireland and Iceland) but there are also success stories (Switzerland and Singapore).  In my view NZ’s legal framework, and the approach of government and regulators, at best reflect an ambivalent attitude to supporting the export of financial products and services from NZ (see for example Cygnus Law’s submissions on the proposed changes to the FSPR law).

Easy Wins

Whatever decisions are made, NZ has a key advantage in that it is an easier place to do business than many other countries.  For example, financial services regulation in the UK is significantly more complex than in NZ (though good regulation can also be a benefit).  However, in my view we have, in some respects, failed to support financial services businesses through effective regulation and government support.  I think that reflects the absence of a true strategic approach to policy for the sector as a whole.  Issues (which I think could be easily resolved) include:

Below is an article I wrote that was published on NZ’s Good Returns website.

Roboadvice for risk insurance advice is less developed than for wealth management, but it is already here in some guises e.g. automated assessment tools from Quotemonster and Strategi. Many businesses in New Zealand are actively investigating roboadvice initiatives for the consumer insurance market. Those initiatives will produce services that support human advisers and that also replace them. That and proposed changes to law are a substantial threat to advisers and also present significant opportunities. I briefly consider key factors that will drive change in the risk insurance advice sector and a possible response.

Fintech Future

The fintech sector has grown enormously in the last three years- $19.1 billion was invested in the sector in 2015 worldwide. There is no doubt that technology will have an increasingly significant impact. It already has in many other sectors, the impact of Xero on accountants’ businesses being just one of many examples.

Financial advice is a natural target for digital disrupters because much of the advice process can be easily reduced to algorithms and on-line processes. An example is PolicyGenius in the US, which provides online, end-to-end, personalised roboadvice on risk insurance. Also, fees are high, which attracts entrants.

Younger consumers are not only comfortable engaging with service providers on-line, most now expect to. This was highlighted in Minter Ellison’s report on roboadvice prepared by its millennial staff. While younger consumers currently have relatively little to invest (slowing uptake of roboadvice for wealth management) they are a key market for risk insurance.

Current Model

The current advice process is outmoded, often comprising multiple face-to-face meetings. There is no clarity on what an adviser is paid or what impact that has on adviser behaviour. The lack of confidence this causes is reflected in consumer surveys.

Consumer insurance advice businesses are often small, relying on outsourced service providers like dealer groups and compliance consultants. One consequence is that there are no consumer brands in the insurance advice sector and limited consumer awareness of the benefits of insurance advice. Insurance advisers have the option of getting licensed now but, of the 56 QFEs, only two are insurance advice firms, both focusing mainly on businesses. Overall, existing industry structures and models haven’t responded effectively to previous regulatory change and aren’t well placed to respond to upcoming challenges. In contrast larger businesses that face disruption (like banks) have, recognising the risks, embraced technology and innovation –they’re better placed to benefit from regulatory and technological change.

Risk

New financial advice law is likely to be in force by late 2017 and will be a trigger for major change. That’s not just because roboadvice will be permitted (true roboadvice could be provided under the current regime). The removal of the class/personalised advice distinction will make it easier for product providers to provide personalised advice services enhanced by efficient robo tools.

The key risk for the advice industry is that it doesn’t adapt, becoming a marginalised channel, out-competed by product providers and new entrants. But adaption that consists of doubling down on the existing model with cost cutting and a Facebook page is unlikely to work. Wearing polo shirts or offering Starbucks to attract millennials definitely won’t!

A Possible Response

Risk insurance is complex and consumers should ideally have advice. Product providers (and tied advisers) won’t necessarily provide the best advice (the “consumers’ interests first” standard won’t change that). Actual and perceived independence is the unique selling proposition that will allow advisers to distinguish themselves from other advice channels. But to achieve that advisers may need to move to an upfront fee model (or full fee disclosure)- easier as the efficiencies of innovation bring costs down significantly.

To continue to compete on service advisers will need to embrace substantial, rapid and sometimes difficult change. That probably means operating as a true corporate and at scale, with front-end services increasingly delivered on-line (or by relationship managers using robo tools), and with a client’s key relationship being with the business not individual advisers. Such businesses would have sufficient resources and capability to promote themselves effectively to a mass market, to operate more efficiently and to innovate.

The future is bright for risk insurance advisers who embrace change and real innovation.

Below is a blog post I wrote for PledgeMe on 25 August 2016 about what to expect as an investor in an equity crowdfunded NZ company.  Companies considering using equity crowdfunding to raise capital can find detailed information in Cygnus Law’s Equity Crowdfunding Guide on legal factors you may need to consider when getting ready for, and running, an equity crowdfunding campaign.

Crowdfunding is an exciting development but what does it mean to be an investor? When it comes to equity crowdfunding it means that you own a part of the company – you own shares.  You ultimately benefit if the company is successful, but you also risk losing your whole investment if it isn’t.  I’ve briefly considered below some of the things you can expect and can do once you’re an investor.

Communication

You can hopefully expect good communication from the company.  While at law the company has limited obligations to proactively communicate with you (and very few if you hold non-voting shares), there’s an expectation that crowdfunded companies will regularly update you on their progress.  If you have voting shares then you can expect an annual report before the annual general meeting (AGM).  Also, as a shareholder and regardless of the rights attached to your shares, you have the right to request information from the company, but they aren’t obliged to provide that information (and might impose an administration fee), particularly where it is commercially sensitive.  You do have a separate right to inspect and ask for copies of certain company records, including shareholder resolutions and financial statements.

The AGM

The company must hold an AGM (and invite you!).  It’s an opportunity to find out more about the company’s progress and future plans and to ask questions of the directors (the company might make it possible to attend using technology). Tea and biscuits (or something better) might be laid out for you.  Or they might not, so check beforehand if refreshments are your main reason for turning up! An AGM must be held within six months of the company’s financial year balance date so, if that’s 31 March (which it usually is), then you can expect an AGM to be held no later than the end of September.

Rewards

The company might have offered shareholder discounts as an incentive to invest.  So use them if they’re of value to you.  But if you’re getting more than minor discounts check to make sure that the company has made arrangements to deal with tax arising – some companies pay your share of tax for you.

Selling your shares

You can sell your shares, though the law places restrictions on sales in some situations.  There is currently no stock exchange for trading crowdfunded shares so finding a buyer might be difficult.  If you do want to sell you could contact the company to see if they know of potential buyers (though because of restrictions at law the company may have limited ability to assist).  However you may not be looking to sell.  Many investors invest with other goals in mind.  You might have invested because you believe in what the company is doing (and are less concerned about an economic return).  You may have invested to enjoy shareholder discounts, to earn dividends, or to benefit from a future sale of the company or its business (though this is by no means guaranteed).  Or you may have a  mixture of those goals.  Dividends are probably unlikely for long periods where the company is growing fast, since the focus is on reinvesting profits to support sustained growth and hopefully significant value add.

Enjoy the ride!

Enjoy the ride and remember that this post is a very broad (and incomplete) summary only and is not legal or financial advice.  The Financial Markets Authority provides useful information for investors.  The law is complex and investing is risky so make sure you seek appropriate professional advice before acting.

Equity crowdfunding was conceived as a way for early-stage ventures to raise capital in their home markets. Few early-stage companies can afford the time and cost involved in preparing a prospectus or product disclosure statement (PDS) ordinarily required for a public offer, but crowdfunding regulations provide a way of making a public offer, subject to annual fundraising caps noted in the table below, and other restrictions.

crowdfunding-regulation

This blog was prepared by Nathan Rose & Simon Papa.  The information in this blog is correct as at June 2016.

See Cygnus Law’s Equity Crowdfunding Guide for detailed information on legal factors you may need to consider when getting ready for, and running, an equity crowdfunding campaign using a licensed platform in New Zealand.

The caps only apply to offers to retail investors and without a prospectus/PDS. More lately, the platforms that facilitate these raises under crowdfunding regulation have been extending their services to include offers under securities law exemptions (e.g. to sophisticated/accredited investors), parallel offers in multiple countries, and prospectus offers. “Equity crowdfunding” appears to have expanded beyond its original definition. 

Brewdog in the UK offered a prospectus when it raised funds through Crowdcube and on their own site. This prospectus allowed Brewdog to escape the EUR5 million limit that non-prospectus equity crowdfunding offers must abide by. Syndicate Room has also embraced this broader definition, when it was approved as a member of the London Stock Exchange, and acted as an intermediary for the initial public offering of HealthCare Royalty Trust.

Equitise in New Zealand/Australia (but operating under a NZ licence) has been innovative. An Australian company undertaking an IPO and ASX listing in Australia, Dongfang Modern, also offered the shares through Equitise’s platform to NZ investors. An offer for SKINS in Europe through Seedrs was also made through Equitise, to NZ investors as a “standard” crowdfunded offer and to sophisticated investors in Australia (which has yet to permit retail equity crowdfunding).

What these examples highlight is the extent to which regulations facilitating internet-based equity offers have introduced wider change, which has leveraged off the platform technology developed and the drive to innovate.

With these additional options on the table, the various pluses and minuses of different uses of equity crowdfunding regulation need to be properly considered by companies seeking capital. The table below gives a summary of factors to consider in relation to common capital raising options.

table

Option 1. Retail equity crowdfunding offer

Using the equity crowdfunding regulations to make an offer of shares to the public is the simplest approach, and the one which will still suit many early-stage ventures. It provides the publicity benefits that are one of the hallmarks of crowdfunding, while being far less burdensome to prepare than a prospectus offer and potentially imposing fewer on-going compliance obligations.

So long as your company isn’t overly concerned about privacy and doesn’t need to raise more than the cap mandated by crowdfunding regulation, retail equity crowdfunding is a potential option.

Option 2. Sophisticated / accredited investor offer

As this avenue keeps the offer more private, the business plan, financials and valuation of your company will not be exposed to the public. For some businesses, the disadvantage of revealing this commercially sensitive information to one and all may be too important to trade off against the publicity advantages.

This option also allows an uncapped raise, but will cut down the audience that can be marketed to. If you have confidence about the investors you have lined up, using an equity crowdfunding platform to facilitate these raises may be for you.

Option 3. Prospectus/PDS offer

A prospectus or PDS offer gives you the ability to raise as much as you like and to market to anyone, including retail investors. It isn’t crowdfunding regulation, but crowdfunding portals can still use it.

They are, however, very time-intensive and costly to prepare – they follow a prescribed format and will likely require a lot of hours from professional service firms. In some countries such offers can only be made by a public company. Also consider the additional reporting requirements following the raise – depending on the country, you may need to produce annually audited financial accounts or use of proceeds schedules. There may be other on-going compliance obligations as well, including in relation to disclosure and record-keeping.

Reckon on tens-of-thousands of dollars of expense, just to get to the start line. If you can cover this cost, by all means, consider the prospectus/PDS route to enable the greatest amount of flexibility in capital raise amount and investor base to market to.

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Deciding on how and whether to raise capital is a big decision. Different platforms specialise in each of these options, so seek out their opinions about what you want to do and ask about their experience. And most importantly, surround yourself with good advice. On that topic, securities law is complex and this article is provided as a broad overview, is not legal advice and should not be acted or relied upon without seeking legal and other expert advice.

In January 2016 Cygnus Law made submissions to MBIE proposing changes to law to address the problems presented by unsupervised NZ building societies.* The underlying issue is that loopholes in the Building Societies Act 1965 have been used to register closely-held building societies and to then use those building societies to operate overseas with little regulatory oversight in New Zealand. The latter issue arose in part because of the Reserve Bank’s decision to not supervise those building societies under non-bank deposit taker law (with the law later changed to remove such building societies from the definition of a non-bank deposit taker entirely). Interest.co.nz editor Gareth Vaughan has written extensively about such building societies.

What is a building society?

Building societies everywhere are intended to be (and are viewed as) conservatively run mutual organisations that take deposits and provide housing loans to members within their own countries (or specific regions within them).  Unsupervised NZ building societies can trade off that reputation even though they don’t have those characteristics.

Who would law reform affect?

Examples of two building societies that have utilised the loopholes are General Equity and Kiwi Deposit. In each case they met the requirement to have at least 20 members by incorporating 20 related shell companies to act as members. Ownership and control was effectively concentrated in the hands of very few people. A third building society, Safe & Sound, has a wider membership base but, like General Equity and Kiwi Deposit, appears to largely operate overseas. All of its directors are Australian and, while having a registered office in New Zealand, it appears to operate from a residential suburb in Brisbane.  There seems to be little, if any, benefit to New Zealand from enabling such building societies to operate.  Experience indicates that some create a real risk of causing significant damage to the reputation of New Zealand’s financial markets.

What are the issues?

General Equity illustrates the issues that can arise. It was the subject of a 2014 FMA warning (warning anyone dealing with General Equity to exercise extreme caution) and on 16 February 2016 it was deregistered from the Financial Service Providers Register (FSPR) at the direction of the FMA. The FMA can direct deregistration where an entity’s registration creates a false or misleading appearance of regulation in NZ or is otherwise damaging to the integrity or reputation of New Zealand’s financial markets. However, General Equity’s status as a building society in the circumstances is itself likely to create a misleading appearance of regulation in New Zealand.  Deregistration usually prevents an entity from continuing to provide financial services but General Equity’s website indicates it is still providing financial services. General Equity has continued to be in breach of law by failing to file financial statements and annual returns. Kiwi Deposit is in liquidation and at this stage it appears that creditors and shareholders will suffer significant losses.

Potential solutions

Cygnus Law’s submissions propose a number of fairly simple steps that could be taken to close those loopholes and to reduce the risks posed by such building societies. For example, by requiring that New Zealand building societies be restricted to providing services in New Zealand and/or by requiring that unsupervised building societies be converted into companies.

Law reform

These issues highlight a problem experienced by other special purpose entities that provide (or are able to provide) financial services and products, being friendly societies, credit unions and industrial & provident societies. They’re subject to out-dated legislation- the governing Act for industrial and provident societies is 116 years old.  While the law has been updated from time-to-time it is still not to a standard of modern legislation.  This creates the risk of the types of issues highlighted above.  Proposed reform was put on the back-burner in 2011 but there are current proposals to address some issues.  The submissions are seeking to introduce additional changes to law through that process.

Simon Papa

* Note: The submissions refer to the previous law under Part 5D of the Reserve Bank of New Zealand Act 1989. Part 5D was superseded by the Non-bank Deposit Takers Act 2013 in May 2014, which brought in a licensing regime.  However, this does not affect the issues raised or the proposed solutions in any material way.