Presentation by Elaine Campbell to the IFA Conference 2014

What does success look like in the new regulatory environment?

Good Afternoon.

I am grateful to speak to you today – as FMA’s adviser work has only recently been brought within my mandate. So it’s a very timely opportunity to speak with you about how I’d like our regulatory relationship to be in the new environment we’re all facing. So I look forward to spending more time with you, during the breaks today and of course in the future.

At most, there around 90 people delivering FMA’s compliance function – that’s across all of FMA’s licensed and monitored populations.

This means as a regulator there are limits on what we can do directly. Because of this, much of our work depends on others to help deliver our message. People like you.

The reality is that you are not going to help us if we’re not helping you. So it is fundamentally in my interests to be concerned by your concerns – because to deliver the outcomes we are trying to achieve in financial services is, to a considerable extent, in your hands.

That we are motivated to engage with you, and address concerns you might have, is evidenced by our engagement with industry – across a range of issues. For example, the Information Return in the Regulatory Reporting Guide, the new regulation of DIMS and issues that have arisen during the implementation of the AML/CFT Annual Return. I’ll talk more about this later.

To help me prepare for today, I wanted to get a deeper understanding of what advisers were saying about the current challenges and opportunities in their industry. I didn’t want to be entirely guided by headlines on blog sites, but wanted to hear in your own words the opportunities and challenges as you saw them.

So over the past few weeks we spoke with a number of advisers asking questions on those two issues. There were some quite clear themes emerging from these discussions. Although moods in the market vary, on the whole those I spoke to were genuinely positive about the outlook for their business.

What won’t come as a surprise to most, if not all of you in this room, is that many of those I spoke to voiced their concerns around the amount of time spent on compliance. I want to assure you that this is something we are well aware of. Our personal engagement reinforces the findings of most surveys you read, that regulatory burden is the top concern across the whole financial markets industry.

That said, many who I spoke to, who are embracing the changes and getting on with embedding the requirements of the new regime, acknowledged that much of this change was needed and is vital to helping restore and rebuild investor confidence. This is a view FMA clearly shares.

But we appreciate that right now there is a point in time pain, for broader gain. And this pain might be being felt most acutely now, as a number of obligations coalesce. But on balance, it is our view that the regulatory burden is about right.

And as you can see in recent coverage from our surveys (reference to slides) that show investor confidence on the rise, we are starting to see some results. From where we sit, we are seeing green shoots of investor confidence which is encouraging for the adviser industry, and there is also a wider focus on building consumer and investor financial literacy.

In any significant regulatory change, there are going to be teething problems, requirements might not quite work or achieve their intended purpose. In these circumstances we are committed to working with you to find solutions.

One example of this has been our work with industry on the annual information return, soon to be submitted by AFAs as part of the Regulatory Reporting Guide. The regulation of DIMS is another area where we’re working together to develop a suitable framework that we can all work with. However, we all have more work to do if we want to see trends in increasing investor confidence continue and gain traction.

So against this backdrop, today I’m going to cover five areas. Hopefully I can draw some threads together about what we look for in market participants and how you can you successfully embrace these regulatory changes from the regulator’s perspective. Then of course I’ll be happy to take any questions.

What does success mean?

For investors, success means having confidence in the market, making informed investment decisions based on sound advice and building their wealth.

For advisers, success means giving sound investment advice – retaining and bringing on new customers and ultimately growing your business.

And, for FMA success is about working together with industry to bring about willing compliance, having confident and informed participants and growing NZ’s capital markets.

If we can align the interests of all three stakeholders then this is the true measure of success.

Where we can help grow your business, creating confident, informed and well advised investors and grow the numbers of investors participating in our markets.

Where businesses have access to capital.

Where investors have confidence because they believe markets participants will do the right thing.

Where FMA can work to assist participants to do the right thing; then that sounds like success to me.

And really it is about those imperatives for success that have driven the regulatory change we see today.

Why change?

It all started with the Review of Securities laws in 2005. There was a need to modernise a complex collection of laws for financial products and markets. The existing regime dated back to the 1960s and 70s, resulting in several shortcomings. It provided an inconsistent set of investors’ rights depending on the legal form of investment or savings vehicles. This cannot be a good outcome if we are seeking to grow investor confidence.

The new regime also seeks to implement recommendations from the Capital Markets Development Task force – aimed at growing NZ capital markets.

The performance of financial markets regulators was also at issue. Regulators did not have the right set of tools to achieve successful outcomes. Tools such as licensing requirements and controls over authorisations were largely absent. Regulators also had limited effective enforcement tools.

Under pinning all of this was low levels of investor confidence and trust in our financial markets – in part off the back of finance company failures, and low levels of capital raising with a high cost of capital for business looking for capital to grow.

So the new regulatory environment is informed by a desire to:

- address the criticisms of the past regime

- to encourage investor confidence and participation

- lower the cost of capital

- and increase the breadth and depth of our markets.

That is what success of the regime will be judged against –meeting these aims.

So how exactly does the new regime intend to do that?

To give you a practical example in one area where change is needed and will be delivered, is in respect of investor information, specifically IPO documents.

The size of the documents produced for some of the larger IPOs that we’ve seen over the past year or so have been very long documents, with a legal compliance focus. Over 200 pages was almost the norm for IPO offer documents in 2013. It is easy to see these documents may be overwhelming and difficult for retail investors and in turn perhaps hard for you to communicate or promote to your clients.

The size of these documents has an impact. A New Zealand investor survey recently conducted on behalf of FMA and NZX by Colmar Brunton supports our concerns that investors are alienated by large and complex offer documents. The survey focused on recent IPOs – which particularly set out to target retail investors and found that few people are reading all of the information and only 52% read most of it. But against all of that, the survey also showed investors want to be able to access the information in the offer document. In fact it was the top source of information for investors about the IPO.

This gives you a practical example of the types of issues we’re trying to address in the new regulatory environment. There is no point in producing investor materials – and that is what they are, not legal compliance documents or risk management tools for directors – that investors don’t read. Our goal must be to ensure these documents serve the interests of the intended audience.

Growing market confidence

When we talk with market participants about the new regulatory environment, specifically the FMC Act, and about how the framework that the Act gives to us can help grow market confidence, we focus on five key change areas and the impact we seek to achieve in each of them.

  • Clear information for investors through clear, concise and effective information in product disclosure statements supported by information on publicly searchable online registers and consistent financial information.
  • Competent market services providers through licensing and ongoing monitoring, showing minimum competence to provide financial services.
  • Fair conduct and dealing standards, an overlay that raises the bar for financial market participants and I am going to explain this in more detail shortly.
  • New ways to raise capital through stepping stone financial markets, peer-to-peer lending and crowd funding.
  • Participants held accountable through governing documents that are fit for purpose, with clear duties for issuers and supervision by ‘supervisors’ with clear duties and powers to act.

Embedding a new approach – Putting the interest of consumers first

The Act brings change right across financial services in New Zealand. In regard to conduct, it brings in a new fair dealing provision – a catch-all provision which applies right across financial services – and that provision prohibits misleading or deceptive conduct.

It broadens the mandate for FMA and enables us to look at issues where we have concerns – it gives us an ‘in’. Boiled down, the conduct provisions of the new Act say to professionals:

Make sure you put the concerns of the consumer first. Always.

This is not a new concept to AFAs who have always had this obligation in Code Standard 1. But the FMC Act imposes new provisions which will bring the rest of the finance community up to the standards we already expect AFAs to be meeting.

So what does putting the interests of consumers first mean? Well you would have heard our views on this in the past – so I am going to paraphrase from Rob Everett, FMA’s Chief Executive.

It does not just require truthfulness. Indeed, we would expect that as a minimum. It requires financial services professionals to go much further, and ask themselves questions such as:

Is this really the right product or service for this client?

Does this client really understand the downside risk and what that might mean to them in a material sense if that risk comes to pass?

Should I be advising this client on other actions they can take, such as risk mitigation?

Put another way – the entire financial services industry – needs to stop thinking about what the customer will pay for and start thinking about what they actually need and what will actually benefit them. In retail financial services – there is a big difference between what people can be persuaded they want and what they actually need.

Raising standards above the minimum

The new regulatory environment will challenge all of you to do more than just the minimum. If you do that, you will be successful in the new regulatory environment – at least from FMA’s perspective.

So what do you get in return for this? If you are making genuine good faith attempts to reach good outcomes for markets and customers, we will be supportive and pragmatic.

We will not be a regulator who applies regulation in a pedantic way – something to be endured and chipped away at. We won’t demand things that aren’t material – we will act where there are sound reasons to do so and in a manner that is proportionate to the risk we perceive.

But we do expect you to play it straight – those who put their own interests first, who shrug in the face of harm to the market, or who decide not to co-operate with us (or to co-operate grudgingly and defensively) will see a very different face of the FMA.

What these changes mean for you?

The scope of FMC Act is incredibly broad but having been part of the first round of reforms with the Financial Advisers Act 2011, financial advisers aren’t in the forefront of the upcoming changes.

There will however be some impacts on the law for you in the area of licensing for DIMS, and I will talk about that. I will also talk about two other key changes that the FMC Act will deliver that are relevant to you – because these changes enable you to have a different conversation with your clients or potential investors.

I’ll also outline some key areas of change outside the FMC Act that you will need to be on top of to remain compliant.

My colleagues have recently been travelling the country reaching out to AFAs to explain how the changes to DIMS will affect you. The changes affect AFAs providing DIMS because, for the client, a discretionary service can have similar outcomes to a managed investment product.

Again the aim is to raise standards of market conduct across the board, and improve investor confidence in these services. We recognise that these aims have to be balanced with the additional compliance costs put on your businesses. That’s why further changes have been made to the regime to allow certain limited discretionary services to be provided without having to meet new, higher, eligibility requirements.

This new contingency DIMS exemption, together with the new transitional provisions that allow more time for businesses to adapt to the new regime, are a direct response to concerns raised by AFAs. The target of improving investor confidence remains the same, but changes have been made where regulation isn’t ‘fit for purpose’.

As discussed earlier around IPOs, receiving clear information about investment opportunities helps investors make sound investment decisions. As part of the new regime, the provision of clear, concise and effective information for investors will be promoted by:

  • Short page limits for Product Disclosure Statements (PDS) so investors receive clearer, more concise, retail investor-focused information.
  • A level of prescription in the PDS to help make the offer documents accessible to retail investors and assist understanding of key information about the offer.
  • Short and focused risk descriptions in the Key Information Summary at the front of the PDS, and a move away from disclosure of long lists of generic risks that are unlikely to be understood by retail investors.

The register will provide a rich vein of supporting information for investors if they choose, and will enable you to carry out more in-depth research and analysis to better advise your clients. This new framework comes into effect on 1 December 2014.

The other area of change relates to governance. Part 4 of the FMC Act resets the accountability framework for managed investment schemes and debt securities from 1 December 2014. These changes are important because they enable you to change the dialog with our clients. The key driver of this change is to address risk of loss to investors from:

  • Mismanagement by product providers.
  • Inadequate management systems and processes.
  • Lack of accountability.

Managers of managed investment schemes must now also act in the best interests of investors. All of which is good news for your clients. At a basic level, the new framework is about ensuring that the main risk faced by investors is the investment risk they agree to take on when they signed up – not operational risk on the part of issuers. This is vital to ensuring your clients have confidence in the management of the products they are investing in.

A key point is that the issuer/manager’s role should be clearly set out and the supervisor (the front line regulatory in this space) holds them to account for doing it. In turn, we’ll be holding the supervisor to account for their supervision.

Implementing the current regime

Much of today has focused on the FMC Act. However we know it is only one of many changes you are absorbing. Other changes are now a reality and success in the new regulatory environment means also being able to keep abreast and on top of those changes too. I’m going to briefly examine three other recent changes in your environment.

  • AML/CFT Annual Return.
  • AFA Information Return.
  • New Code of Conduct.

AML/CFT Annual Return

We are aware this is an area where AFA’s are currently voicing concerns. We recently published additional guidance to help you provide the correct information when answering Question 6.1 of the annual AML/CFT report. This includes what to consider when counting the number of transactions and value of transactions.

We acknowledge that the question in the report was open to interpretation and that there are practical difficulties in collating this information. We have actively engaged with AFA industry bodies on this issue to find a mutually acceptable solution and we acknowledge that this solution has not been supported by everyone.

For this reporting period all we require is an estimate. We do not intend to take any action as this requirement beds in, where best efforts are being applied to comply. We accept that some advisers have genuinely had a different view on what it will be necessary to report and we have advised that we will accept this.

Ambiguity in what the law means or how we interpret and implement is not in either your or our interests. We will seek to have the law clarified to address this. We will also seek to make allowances for AFAs to provide any required AML/CFT information within one consolidated annual return.

Why do we need this? I think this is useful for you to think about the purpose of providing the information to FMA. AFAs are within the regime due to the business they arrange. The annual reports will help us ensure that the information we have on your business is current; allow us to better understand your business and the controls you have in place to reduce the risk of money laundering and terrorist financing occurring through your organisation; and help us determine whether a compliance review or monitoring visit to your organisation is necessary.

AFA Information Return

The Information Return is the first reporting requirement contained in the Regulatory Reporting Guide (RRG). It is an online tool that each AFA will need to complete and submit annually to FMA.

It consists of a series of questions about you, your business, your compliance approach and your approach to continuing professional development. The Information Return will assist us in our risk based approach to the monitoring and surveillance of AFAs and to allocate our resources effectively.

New Code of Conduct

Finally, I want to acknowledge that advisers are also dealing with the new Code of Conduct released in March. Changes to the Code centre around the standards relating to ethical behaviour, client care, competence, knowledge and skills, and continuing professional training so it is important that you focus on these key areas.

Our expectations

I have said earlier that success to FMA is about willingly compliant participants. We are seeking to foster a culture in which market participants proactively work to set appropriate standards, put in place a robust approach to managing and monitoring compliance, and willingly share information with us, including reporting breaches.

Our monitoring isn’t designed ‘to catch you’ out on breaches, it is a path by which we can assess whether you are meeting the required standards and if not, take steps to ensure you do. Based on this we will work with market participants to help them willingly comply by:

  • Developing a framework that encourages participants to promptly report and correct errors or breaches.
  • Having direct engagement with participants – through consultation programs.
  • Issuing guidance, factsheets, and setting clear expectations.

However, where the misconduct is serious, where the customers interests have clearly been put behind your own, or we see participants who ignore investor harm, then we now have substantial powers to investigate and take action.

So, having set out our expectations – what do you have to do to meet them? What does a ‘successfully’ compliant participant look like to FMA?

This comes back to the earlier comments I made around embedding the new approach and this can be summarised by these two key points:

  • Putting interests of consumers first.
  • Raising standards above minimum.

If you do these two things then from FMA’s perspective you have done what we have asked and you have hurdled our bar.

Helping you be successful

It is important to reiterate the fact that we’re not here to work against you, in fact it’s the opposite – we’re here to help. FMA values the role of advice and the adviser industry and we will continue to emphasise the importance of advisers and the professional advice advisers provide to investors.

You would have seen this was central to our messaging on our recent licensing of Peer-to-Peer Lending services and the recent wave of IPO’s. Our message was clear – ‘this it isn’t for everyone so go get advice to see if this type of investment is right for you’.

We are concerned by advisers leaving the industry, and the aging adviser population and a demographic that doesn’t represent your actual potential client pool. However, I was delighted today to be approving two quite young advisers and I do hope this is part of a continuing trend.

There must be sufficient channels for New Zealanders to get the advice they need, when they need it, on the issues they need to be advised on. The challenge for us is to ensure that the gains of regulation outweigh the costs. We need to ensure regulation does not result in poor outcomes and we don’t stand in the way of growth of your industry and access to the advice that New Zealanders need.

We will listen when things aren’t working (as we have with DIMS) and there’ll be a chance for you all to comment on how the FAA has gone next year when it’s reviewed. Take ownership of compliance and use it as a means to build your client’s confidence and secure the future of your business. If what we are asking you is not clear – let us know.

We don’t get it right all the time and we won’t always agree with you, but we will listen. So pick up the phone, call me, Rob, or my team and talk to us.

On that note, it is time for me to listen to you.

Thank you very much.