News & Thinking
Conduct of financial institutions… the Government hits back
On 25 September 2019, the Government announced conduct licensing and other conduct rules for banks, insurers, and non-bank deposit takers (like credit unions). What will the changes mean?
The conduct of financial institutions continues to make headlines, both in New Zealand and overseas. It is front of mind and a major focus across the sector, and dominates the industry agenda.
In April, the Ministry of Business, Innovation & Employment consulted on options to close the gaps (see Anthony Harper’s commentary here) and on 25 September Commerce and Consumer Affairs Minister Kris Faafoi announced the Government’s response.
The Government is hitting back.
The significance of the announcement can’t be understated. These reforms will directly affect banks, insurers, and non-bank deposit takers (such as credit unions), but will also set the standard across the wider financial services sector, and are being designed so they could ultimately be extended to cover others.
Conduct licensing is coming
The Government plans to create a conduct licensing regime for banks, insurers, and NBDTs. The regime will be overseen by the Financial Markets Authority, as another type of “market service” under part 6 of the Financial Markets Conduct Act 2013.
Banks, insurers, and NBDTs will need to meet a high level “fair treatment” standard, supported by detailed obligations (more on this below). These licensed institutions will need to implement effective policies, processes, systems and controls to meet the fair treatment standard. Regulations (and, we expect, licensing conditions and guidance from the FMA) will specify what these policies, processes, systems and controls have to include.
Despite the April consultation we are genuinely surprised about conduct licensing. Banks, insurers, and NBDTs already need a prudential licence from the Reserve Bank, so this means they will need two licences to operate (and probably more, for specific activities like financial advice), and will be overseen by two regulators. This has inherent inefficiencies, even with the FMA and Reserve Bank working closely together. Another licensing regime also has the potential to impose considerable cost – something the supporting materials specifically acknowledge.
The only good news for those affected is that there is scope for a proportionate approach so that smaller or lower risk institutions are not subject to the same degree of scrutiny.
A high-level fair treatment standard
“Fair treatment” replaces the duty to prioritise the customer’s interest, which was consulted on in April. In the Government’s mind, “fair treatment” means customers can have confidence that they are dealing with financial institutions that place their fair treatment at the heart of their business.
In terms of more specific actions, it means:
- giving customers clear, fair, and not misleading information, and keeping them informed
- designing and selling products and services that meet customer needs
- providing products and services of an acceptable standard, and which perform as customers expect
- not placing unreasonable pressure on customers
- effective and transparent complaints handling.
The requirements will apply to all products and services supplied to retail customers (including small businesses), at all points in the product life cycle.
The fair treatment standard (and the need for effective policies, processes, systems and controls to support it) isn’t a surprise. The specific actions are broadly similar to what was flagged in April, and at a high-level are hard to argue with. However, as with anything, the challenge will be to define what it all means in practice.
Limiting remuneration and incentives
Sales incentives based on volume or value targets will be banned. This will include soft commissions such as overseas trips, bonuses for selling a certain number of financial products, leader boards, and performance management based on the volume of sales. The prohibition will apply to banks, insurers, NBDTs – and their intermediaries – and will cover both internal staff and external intermediaries.
Beyond this, banks, insurers, and NBDTs will need to consider the risks and potential harm of remuneration and incentives, and design them in a way that minimises the risk and is consistent with the fair treatment rule.
The Government does not intend to ban all remuneration and incentives linked to sales or to impose hard parameters around the structure of commissions (such as caps). However, the supporting materials send a signal to the market by saying that “in practice” the new obligation will require life insurers to review commission rates and reduce them if there is a risk of consumers being switched unnecessarily.
Banks, insurers, and NBDTs will be responsible for the outcomes of sales to consumers by intermediaries who are not financial advice providers. The requirement will not apply where sales occur through a financial advice provider, although the supporting materials try to have it both ways by saying this does not absolve licensed entities from responsibility for customer outcomes.
There is not a lot of detail on what it means to be “responsible”, beyond a reference to licensed entities having liability for breaches of conduct obligations, and a suggestion that licensed entities will require intermediaries to meet the fair treatment standard (which is probably right).
Limiting distribution responsibilities to non-advised consumers is a good solution. It avoids arguments between advisers and providers about who is responsible for advice provided, and fits nicely with the new financial advice regime. It also means that all end consumers – regardless of how they buy products – will have a licensed entity responsible for their sale.
Specific product design obligations and product intervention powers, which were consulted on in April, are not being progressed at this stage.
The Government says the regime will be backed by “strong enforcement tools” and that financial institutions “will face strong financial penalties for breaching their obligations under the regime”. The supporting detail indicates these will reflect the current Financial Markets Conduct Act enforcement regime.
However, there could be more to come. The supporting materials say that mechanisms to increase senior executive accountability are likely to be progressed in the shorter term. This will be in conjunction with greater accountability for prudential matters being considered as part of phase 2 of the review of the Reserve Bank of New Zealand Act.
Minister Faafoi intends to introduce legislation and refer it to Select Committee by the end of the year (which isn’t actually that far away). We haven’t seen anything that suggests an exposure draft will be released, and the timeframe makes that unlikely, so the first opportunity for comment will probably be at the Select Committee stage.
Ultimately we expect a fairly long transitional timeframe. These are New Zealand’s largest financial institutions, and no matter how fast the Government wants to move it will take time. It’s hard to see the regime in force before late 2021 or early 2022.
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Anthony Harper has extensive experience in conduct and culture issues, and are actively supporting clients across the financial services sector on these issues. We also regularly assist client across all sectors with law reform issues. If you have any questions, or need assistance in your business, please get in touch: