The Financial Markets Conduct Bill (the Bill), which is currently before Parliament, will overhaul New Zealand's securities legislation.
It will replace the Securities Act 1978 (principally dealing with primary markets) and the Securities Markets Act 1988 (secondary markets and futures dealers), along with replacing or amending numerous other pieces of financial markets legislation. This article focuses on one aspect of the new legislation - the power that it will give the Financial Markets Authority (FMA), New Zealand's financial markets regulator, to designate investment products as being subject to regulation or rule on which regulatory category they will come under.
In a sentence, this amounts to the Bill giving the FMA a rulings power as to the classification of investment products. At present the Securities Act defines both "security" and the concept of an offer of securities to the public very broadly, but provides a range of exemptions and exclusions (for example, products giving an interest in real estate). The application of these definitions, and the associated exemptions and exclusions, has not always been clear and there has been relatively little case law.
The resulting uncertainty presents problems for market participants and their advisers. A marked example was seen with the Supreme Court ruling that products offered in the failed Blue Chip property development were securities, and had been offered in breach of the Securities Act – the Supreme Court's ruling came after adverse rulings at first instance and in the Court of Appeal, and the FMA's predecessor agency having reached the view that the products were not subject to the Securities Act.
The power contained in the Bill is intended to remedy this problem by giving the FMA the ability to designate investment products. This new ability will operate in the context of the Bill's new treatment of investment products. The Bill imposes disclosure and governance obligations on offers of financial products, which are divided into four categories: debt securities; equity securities; managed investment products (MIPs); and derivatives. For most purposes if a product does not come within one of these four categories it will not be subject to regulation. The Bill will retain the concept of a "security", but in a more limited sense – the definition of "security" will act as an outer boundary, describing those products that may be made subject to regulation.
The powers given to the FMA under the Bill will include the ability to make designations with regard to licensing provisions and offering exclusions. The key powers, however, that the FMA will have with regard to financial products will be to:
- Declare that a security which is not otherwise a financial product is a financial product of a particular kind (for example, that a particular security which might not otherwise come within the MIP definition in the Bill is, nevertheless, an MIP)
- Declare that a financial product is to be reclassified as belonging to a different category of financial product (for example, that an MIP should be classified as a debt security) or
- Declare that a security that would otherwise be a financial product of a particular kind should not be classed as a financial product.
As would be expected, the Bill provides procedural safeguards around the use of the designation power. The FMA must consult those persons who would be substantially affected by use of the designation power, and must have regard to the economic substance of the security in question. The designation power may not be used retrospectively, but the FMA may make an interim order preventing the product in question being offered while the use of the designation power is considered. The Bill does not provide a right of appeal in respect of the FMA's use of the designation power, so it would appear the only potential for challenge would be an application for judicial review.
The designation power clearly offers the FMA the potential to act where it considers that the offer of a particular product represents a threat to the interests of the investing public. Taken together with the FMA's powers to grant exemptions from disclosure or governance requirements subject to appropriate conditions, the designation power would enable the FMA to assess how a product should best be offered and tailor the relevant disclosure if considered necessary.
The power may also be useful, however, for market participants who develop new investment products. As noted above a major issue around the application of the Securities Act is the uncertainty associated with definitions and exemptions. If the FMA is willing to assist market participants by discussing proposals, and either using the designation power (with appropriate exemptions if necessary) or issuing a no-action letter, the uncertainty associated with the current regime will be reduced, and financial innovation will be assisted.
As with many of the new powers contained in this overhaul of New Zealand's securities legislation, it will be up to the regulator to tread the fine line between ensuring appropriate investor protection, and facilitating market confidence and innovation.