Many in the financial services industry will have been busy putting the final polish to their submissions on proposed increases to FMA levies due last week. But submission season continues relentlessly, with consultation open until Wednesday, 26 March 2020 on the Financial Markets (Conduct of Institutions) Amendment Bill and the Financial Markets Infrastructure Bill. Industry will also be digesting the Government's announcements over the weekend on the KiwiSaver default provider review, and its decision to require KiwiSaver default funds to exclude fossil fuel investments.
Financial Markets (Conduct of Institutions) Amendment Bill
The fallout from the Australian Royal Commission into Financial Services has been widespread, including in NZ where the FMA/RBNZ reported gaps in our regulatory regime for 'conduct' in their joint-reviews of the banking and insurance industries. In response, the Bill seeks to hold banks, insurers, non-bank deposit takers and their intermediaries to a high level 'fair conduct principle'. While not legally enforceable in its own right, the principle would be implemented by requiring banks, insurers and non-bank deposit takers to obtain an FMA conduct licence and put in place a 'fair conduct programme' binding on them and their intermediaries. The Bill also provides for volume or value-based commissions on bank and insurance products to be banned.
Implications for the funds management industry
The funds management industry is not currently the focus of these reforms. However, the definition of 'intermediary' is broad - subject to exclusions in yet to be considered regulations. A key issue for fund managers, distribution platforms and their service providers will therefore be whether they fall in scope as 'intermediaries' or otherwise as part of banking or insurance groups. Given retail fund managers are already subject to FMA conduct regulation under the MIS manager licensing regime, this additional layer of regulation would seem unnecessary and undesirable.
The proposals would put significant additional pressure on an industry already stretched by years of ongoing regulatory reform. Together with the anticipated FMA levy increases (and probable further increases to fund FMA's increased jurisdiction under the Bill), affected business will be concerned about their ability to resource for these new regulatory costs. The speed at which the Bill has been prepared means much of the detail, such as exactly what commissions will be banned and what the fair conduct programme must cover, has been left to regulations. The principles-based nature of the rules also introduces some legal uncertainty. These and other factors have made the Bill politically controversial, with the opposition voting against it at its first reading (albeit in an election year).
Financial Markets Infrastructure Bill
Financial Markets Infrastructures (FMIs) are multilateral systems used for the purposes of clearing or settling payments, securities, derivatives or other financial transactions. RBNZ and FMA currently regulate FMIs that have opted in to the oversight regime voluntarily.
The regulators' view is that an enhanced regulation of FMIs is necessary because FMIs play a key role in the operation of the financial system, and any disruption or failure of an FMI could affect the financial system as a whole, creating major solvency and liquidity problems. The International Monetary Fund's 2016 Report also recommended that the oversight regime be reviewed and uplifted in order to comply with international best practice.
Under the new Bill, the RBNZ and FMA will continue to jointly regulate FMIs (except where an FMI is designated as a pure payment system - then the RBNZ will be the sole regulator). FMIs will fall into two categories - designated and non-designated. FMIs will be designated if the regulators determine they are systemically important or they opt-in to being subject to the regime. All other FMIs will be non-designated.
The regulators will be able to require information, reviews and independent reports from both designated and non-designated FMIs. For designated FMIs, regulators will be able to issue legally binding standards, require them to publish their governing rules and to obtain regulatory approval for changes to these rules. The Bill will also give the regulators broader crisis management powers - designated FMIs will need to have business continuity plans and the regulators will be able to remove directors from their Boards.
Implications for the funds management industry
The four payments systems that are already designated are likely to be designated again under the new regime, including NZClear. This is likely to impact entities that provide trustee services that are NZClear participants.
Given that NZClear is already designated, we do not expect the additional impact of the Bill on to be significant for participants. However, the regulators will be able to issue legally binding standards that participants will need to comply with, and will have greater investigative, enforcement and crisis management powers. Participants will need to review their rules and make any changes to align with these new standards, and any future changes will need to be approved.
Increased oversight of FMIs was inevitable in light of the IMF's review in 2016, which concluded that the currently regulatory framework did not provide sufficient oversight of a sector critical to New Zealand's financial system. The Bill is needed to bring New Zealand in step with international standards and we anticipate it receiving support from most impacted parties.
KiwiSaver default provider review announcements
The Government announced key decisions over the weekend on the KiwiSaver default provider review process. The headline item is to require default funds to exclude fossil fuel investments. But the announcement also includes a number of other important decisions:
- Changing the investment mandate from ‘conservative’ to a ‘balanced’ fund.
- Using the default provider procurement process to put pressure on fees and make fees 'simple and transparent'.
- Putting obligations on default providers to engage with their members to help them make active decisions about their retirement savings.
- Requiring default providers to maintain a responsible investment policy on their website.
- Transferring non-active default members (i.e. those that have not made an active investment decision) of any provider that is not reappointed to one of the appointed default providers.
These will form part of the default provider review process starting later in the year and will take effect when the new default providers' terms commence on 1 July 2021.
The ban on fossil fuel investments is unexpected but probably not surprising given the current Government's position on climate related issues. The decision to transfer non-active members where a default provider is not reappointed reflects this, laying down a clear financial incentive/expectation for default providers to engage in the review and comply. However, what constitutes a 'fossil fuel investment' (e.g. car makers?) is still be revealed and more fundamental questions remain about the effectiveness of investment exclusions to achieve substantive policy outcomes.