On 28 June 2013 the Minister of Commerce, the Honourable Craig Foss, announced a package of decisions regarding the regulations that will be made to give effect to the Financial Markets Conduct Bill (FMC Bill). The Minister's press release can be found here and also provides a link to the relevant Cabinet papers.
In this update we discuss the decisions that have been made, what is yet to come, and the implications for market participants. The update is divided into four sections:
- An overview of the decisions made, and what they mean
- The decisions made around disclosure documents and offering processes
- The decisions made relating to the governance of debt and managed investment products
- The decisions made regarding market services licences.
OVERVIEW OF THE DECISIONS MADE
What are the decisions that have been made?
The first point to note is that while Cabinet has decided on making regulations, there's still a long way to go. The regulations will need to be drafted, circulated in draft form so that market participants can comment, and then revised to incorporate the feedback from this process. The draft regulations (in most areas) are expected in October this year.
The Cabinet decisions are about the form that the regulations will take. As such they give useful information to market participants on what to expect. They are necessary as much of the detail that is needed to make the FMC Bill is to be set out in regulations, rather than in the Bill itself – for example, the Bill tells us which categories of market participants will need to obtain a market services licence from the Financial Markets Authority (FMA), but the regulations will set out what requirements must be met.
The policy decisions have been set out in four separate Cabinet papers – one providing an overview of the process, and the other three discussing disclosure, governance and licensing. We have followed the same structure in providing this update.
Overall the process being followed by the Ministry of Business, Innovation and Employment (MBIE) is a sound one, of providing increased amounts of information and opportunities for public input. We hope it continues, but as we note in this section there are parts of the overall project that might experience delays, with a risk that officials might be tempted to take short cuts.
What is still to come?
There are two principal areas outstanding. The first is further detail on what market participants will need to disclose when making a regulated offer of financial products – the contents of the Product Disclosure Statement (PDS). As we describe in the disclosure section of this update, while there have been a number of decisions made about the shape of the PDS, we won't find out what information is required in the PDS for some time.
The second is further information on the registers that will be established under the new legislation. The intention is that these will provide an easily accessible electronic record of information for offers of financial products and for managed investment schemes. The Cabinet papers refer to these in a number of places, and comments were sought in MBIE's discussion paper in December, but there are no further details provided. The registers are meant to be a key part of the new regime, holding large amounts of data for public access, so if they are not commissioned with sufficient lead in time for testing it will be difficult for the new regime to operate as intended.
When will this come into effect, and how long will we have to get ready?
The FMC Bill is still before the House, but is expected to be enacted 'shortly'. The key date, however, as with most pieces of legislation, will be its commencement date. It is intended that the main operating provisions of the legislation will come into force once the necessary regulations have been made, with a target date of April or May 2014.
As mentioned above, however, this timetable may be placed under pressure depending on how MBIE and the FMA carry out the necessary preparatory work in the second half of 2013, so there may be some delays. It is difficult to see how the new regime could operate without the contents of the PDS being settled, for example, and if there are substantial market concerns when the drafts are released, it would seem preferable to delay implementation rather than to compromise on the end result.
When the legislation comes into effect, however, there will be a transition period, lasting up to two years in some cases. There will be more detail to come, but during this period market participants will still be able to use prospectuses and investment statements to raise funds, will have time to update their governing documents, and in some cases have temporary market service licences. In some cases, however, where exclusions have been widened under the new regime (such as those for registered banks), market participants may wish to move to the new regime as soon as convenient.
DISCLOSURE – OFFERING DOCUMENTS, ONGOING DISCLOSURE AND THE REGISTERS, AND EXCLUSIONS
What has been decided?
Cabinet has made a number of decisions regarding disclosure. As outlined above, we don’t yet have a description of the actual contents of the various forms of the PDS – this will be the subject of further consultation. But we do have a number of decisions regarding disclosure, and the offer process more generally.
Key decisions around disclosure
Key decisions around disclosure include:
- Confirming that PDSs will use the "key information summary" format – a one or two page tightly prescribed initial section, followed by further detail in the rest of the PDS
- Defining "managed funds" as a category of managed investment schemes (characterised by having high liquidity or being continuously offered, and being redeemed on the basis of net asset value) and favouring tightly prescribed PDSs for such managed funds to aid comparability
- Favouring a periodic disclosure regime for all managed funds similar to that recently implemented for KiwiSaver schemes
- Favouring a lesser degree of prescription for the PDS of other categories of financial product
- Confirming the use of the online offer register to contain information not included in the PDS, and in particular frequently changing information such as fund performance
- Setting down criteria to restrict the use of the term "secured"
- Agreeing that PDSs can be "evergreen" (that is, with no set expiry date), subject to a general obligation to keep them accurate and, in some cases, a requirement to provide regular confirmation that they remain up to date
- Requiring a board consent for the lodging of the PDS and register information (signed by two directors).
The last item above may prove contentious. A key theme during consultation on the legislation has been the removal of the signing requirement that currently applies under the Securities Act. The proposal to allow a certificate signed by two directors is intended to follow the Financial Reporting Act, and to permit greater flexibility for boards to decide how they wish to supervise offering procedures. Given ongoing discussion (and recent litigation) regarding the role of directors, however, this may be the subject of further discussion.
Ongoing disclosure and the register
The Cabinet decisions affirm the importance of the register of offers of financial products created under the FMC Bill, and the new "feel" of disclosure. In some ways the new regime will be more similar to what we currently have with a listed issuer, with all disclosures being lodged with, and available at, a common source.
While not as onerous as the continuous disclosure obligations imposed on NZX listed entities, the likely periodic and events based disclosure requirements may mean an increase in overall reporting requirements. One piece of potential relief may come with financial reporting obligations for issuers moving to the FMA – having the same agency supervising all disclosures may be of assistance, and may facilitate exemptions where appropriate.
The offer process and exclusions
Another topical area of discussion has been the various exclusions provided for certain offers, most importantly those made to "wholesale investors". The FMC Bill provides for regulations to be made setting out mandatory warning statements or acknowledgments that may be required, as a halfway house.
We have previously reported how the Bill has been amended to raise the $500,000 wholesale offer threshold to $750,000. In addition to this, it is now proposed that a mandatory warning statement must be given where this exclusion is to be relied on and "acknowledged" by the investor. This will not be welcome by wholesale market participants, but hopefully will not create a disproportionate burden.
Similar steps are proposed for a number of other categories of exclusion – for the most part these appear to strike an appropriate balance by making clear to investors that they are not receiving standard disclosure, rather than trying to extend that disclosure.
The exclusion for offers by registered banks has also had a welcome extension, with cash and term PIEs, and currency forwards that settle within 12 months being added to the categories of exempt products.
What do we need to keep an eye out for?
During the second half of 2013 we can expect to see industry consultation on the format that the different types of PDS will follow, and the relevant register entries.
In addition, the Cabinet papers have stressed the role of the FMA in publishing guidance in various areas, and we expect to see various statements from the FMA in this role.
GOVERNANCE OF DEBT AND MANAGED INVESTMENT PRODUCTS
What has been decided?
Part 4 of the FMC Bill is concerned with governance matters for debt securities and the various types of managed investment product.
Key decisions that have been made in this area include:
- Recognising "managed funds" as a separate category of managed investment product, as noted above, and providing for these to be recorded on the register of managed investment schemes
- Providing for the FMA to have the last word on the different categories of managed investment scheme – both for defining these categories and reassigning particular schemes between categories if required
- Confirming that superannuation schemes registered under the Bill can be more flexible than KiwiSaver schemes
- Prescribing mandatory requirements for governing documents (for both debt products and registered schemes) to include matters such as issuer reports
- Prescribing default rules for product holder meetings.
Still to come – review of custodial arrangements
The custody of scheme property is an important issue for managed investment schemes. The Minister has signalled in the Cabinet papers that he intends to undertake further consultation on custody issues, both under the FMC Bill and the Financial Advisers Act – we recommend that market participants keep an eye out for the consultation proposals.
Still to come – further work on supervisors and auditors
The Cabinet paper notes the tension that exists between supervisors and auditors – a campaign that has had several rounds during the development of the FMC Bill. Given ongoing review work currently underway by the Reserve Bank and NZICA, however, the Minister proposes to roll over the existing arrangements pending further work being undertaken in this area.
LICENSING – WHAT WILL BE NEEDED FOR A MARKET SERVICES LICENCE?
Why are regulations being made?
Under Part 6 of the FMC Bill, market participants will need to obtain a market services licence from the FMA to undertake certain services, including funds management, making regulated offers of derivatives, and providing discretionary investment management services (DIMS).
The FMC Bill sets out certain basic criteria for licensees:
- That the licensee's directors, senior managers, and proposed directors and senior managers are fit and proper persons to hold their respective positions
- That the licensee is capable of effectively performing the service in question (bearing in mind any conditions that may have been imposed)
- There is no reason to believe that the licensee will not comply with its obligations as a market services licensee
- The licensee satisfies any relevant requirements set out in regulations.
The Cabinet has agreed on a range of regulations that are to be made, including some general ones that will apply to all classes of market service licences, and some specifically related to particular classes, such as derivatives issuers.
What common requirements are being proposed for all categories of licensees?
A number of common requirements are proposed for all categories:
- An ability for the FMA to require licensees to hold adequate indemnity insurance as a condition of their licence
- Set mandatory reporting requirements for licensees (such as changes in directors or senior managers, or major transactions as defined in the Companies Act)
- Certain terms being implied into all client agreements for retail clients, preventing licensees from contracting out of basic duties such as the exercise of a prudent level of care, diligence, and skill
- Requiring that where a related body of a licensee is authorised to provide market services under the licence, fitness and propriety requirements are extended to the key personnel of the related body.
Cabinet has also agreed to make regulations requiring the FMA to consult the Reserve Bank when considering a market services licence application from an entity supervised by the Bank.
What requirements are proposed for particular classes of licensees?
Cabinet has agreed to make more specific regulations for the different classes of licensees. These decisions include the following key points:
- For independent trustees of restricted schemes, Cabinet has agreed that a whistleblowing obligation should be added as a licence condition, together with corresponding protections
For DIMS providers, Cabinet has:
- agreed certain matters that must be provided for in client agreements, such as custody
- agreed that if investors are being treated as wholesale investors they must be notified of that fact
- agreed to carry over relevant exemptions from the Financial Advisers Act
For derivatives issuers, Cabinet has:
- agreed to impose capital adequacy requirements – leaving these to be determined by the FMA, unless a derivatives issuer is already subject to prudential regulation by the Reserve Bank
- agreed to carry over the general regime of the Futures Industry (Client Funds) Regulations 1990
- agreed that the FMA may impose client suitability requirements and/or leverage limits.
The Cabinet paper is silent on additional requirements for fund managers, the other category of persons requiring a market services licence. This may suggest that no additional requirements are intended other than the "standard" requirements mentioned above.
It is worth noting that at this stage there are no express transitional provisions for fund managers – unless these are provided in some form, this will place considerable pressure on market participants in this field, as otherwise they will all need to be licensed come "D Day".
New categories of licensed person
As indicated from earlier discussion, Cabinet has agreed that regulations should provide for two new categories of "prescribed intermediaries" – person to person lending providers and crowd sourcing providers.
The Cabinet paper sets out draft requirements for both these classes of intermediaries, to supplement the general obligations described above. These additional criteria will be centred around ensuring that the service providers offer "open platforms", meaning that they are neutral brokers between borrowers and lenders (in the case of lending services) and investors and issuers (in the case of crowd funding services), and include matters such as client agreements and disclosure statements about the services they provide.
Overall the parcel of decisions that the Minister has announced give a considerable amount of further information on the shape of the FMC Bill regime that we can expect. We would caution market participants, however, that there is a considerable amount still to come, and a risk of timetables being placed under pressure.