Business now has a firm basis to prepare for the regime to be established by the Financial Markets Conduct Bill and regulations following the release last week of cabinet papers which set out clear directions for the core remaining elements of the programme – disclosure, exclusions, governance and licensing.
The message – particularly for the funds industry – is that the time to begin preparing in earnest for the reforms is fast approaching.
The four papers contain:
an overview of the remainder of the reform process, including a proposed timeframe
disclosure directions and some refinements to the new exemption framework
governance requirements – particularly for the various managed investment schemes, and
principles applying to the new licensing system which will be of particular interest to fund managers, derivatives issuers and other financial service providers.
This Brief Counsel covers the first two papers. Governance and licensing will be addressed separately. We will also produce a commentary on the reforms as they affect KiwiSaver schemes.
Timing and deliverables
An exposure draft of the regulations is scheduled for release in October this year. The regime is then planned to come into force in April 2014, subject to a transitional period of up to two years.
Along with the regulations, the other key – and perhaps even more challenging – deliverable on this timetable is the new securities register. This online platform is as ambitious as it is core to the financial reform package. In addition to providing a one-stop shop for issuer information, it will house the new periodic and event-based disclosures, requiring functionality similar to securities exchanges.
Whether it will be possible to have this tested and in place before the proposed April 2014 commencement date remains to be seen.
The disclosure framework, although fundamental to the reforms, has taken something of a back seat until now, but is centre stage in the cabinet papers.
None of the policies in the papers is a complete surprise as they reflect the content of the admirably transparent consultation undertaken by officials. What the Cabinet has done is bring finality by laying down concrete policy decisions that will be fleshed out in the upcoming exposure draft of the regulations.
While the cabinet papers note that it is premature to consider the detailed content of the disclosure requirements, there are some clear pointers on direction and approach.
Prescription + flex: the fundamental debate between principle and prescription has been resolved by an informed pragmatism, recognising that different products call for different approaches. Prescription will be balanced with flexibility, leaving room for both Financial Markets Authority (FMA) guidance and issuer judgement in developing disclosure standards.
Tailoring: existing ‘one-size-fits-all’ disclosure has been jettisoned in favour of specific mini-disclosure regimes tailored according to product and core underlying principles. In segments where product comparability is paramount – KiwiSaver, managed funds – there will be heavy prescription of format, content and length of the disclosure documents. In those where issuer and industry information is critical – debt, equity, and ‘equity-like’ funds – there will be greater flexibility around length and content, with the primary emphasis on effective presentation of material information.
Templates: the prescribed content will be informed by the preparation of templates, developed with industry and tested with end users.
Funds: for managed investment schemes, the challenges of providing scheme and fund disclosure are recognised. Issuers will be able to meet point of sale obligations by providing documents containing relatively enduring disclosures (such as scheme structure) alongside the most recent periodic disclosure statement containing current performance data and other information (such as actual and benchmark asset allocations and top 10 asset holdings). The KiwiSaver periodic disclosure requirements will be extended to cover managed funds.
The cabinet papers show that the thinking has evolved from an almost single-minded focus on length of offering documents to a more sophisticated approach focused on effectiveness. We commend in particular the decision to use templates in the development of disclosure rules for the various product types. This has great potential to enable the elements of content, format and navigation to be developed together in a coordinated way.
Directors’ consent and due diligence
Following substantial consultation, it has been decided that directors’ consent for the lodgement of offering documents will be evidenced by lodging a statement of the board’s consent, normally to be signed by two directors (rather than all of them, as is currently the case for prospectuses).
The related discussion notes that this structure will be flexible enough to allow directors to “delegate the process for development of disclosure and verifying its completeness and accuracy to others, if it is reasonable to do so in the circumstances”.
Welcome and appropriate as this is, it may run up against the ‘no delegation’ drumbeat emanating from the High Court decision in Lombard,1 which has been partially enshrined in the FMA’s Guidance Note on Effective Disclosure.2 This has since been clarified to a degree in the Lombard appeal, where the Court of Appeal’s analysis – while upholding the High Court decision – is a far cry from the virtual ban on delegation which had been unfairly extrapolated from Dobson J’s judgment.3
The discussion in the cabinet paper is a further step in the right direction.
Describing debt as “secured”
Another significant matter is the use (or misuse) of the term “secured”, particularly in relation to finance company debentures. Here the Minister has signalled that substance will trump form – products will only be able to be described as “secured” if the security is likely to be sufficient to cover losses arising from the issuer’s financial failure.
On-going disclosure for unlisted issuers
Cabinet has also resolved the vexed question of whether to require continuous disclosure from unlisted issuers and, if so, how much. This is an issue that has been debated, without resolution, in papers going back to the original Review of Securities Laws discussion document.
Here again, Cabinet has set the dial to the middle ground – although that still constitutes a significant policy shift. It had already been clearly signalled that the emphasis in KiwiSaver and managed funds has moved in the direction of on-going disclosure. While the equity and debt proposals do not go so far, the new regime will require more than the periodic and request disclosures currently required.
The Regulatory Impact Statement accompanying the cabinet papers makes it clear that the decision here was a cost-benefit exercise. Officials advised against full continuous disclosure by unlisted issuers, citing compliance costs. Instead, for both debt and equity, the required periodic disclosures will be augmented by event-based disclosure. For debt, this would be specified key matters impacting credit. For equity, it would include significant changes in the business – including major transactions.
The event-based disclosure will be placed on the online register. The obligations will not apply to issuers subject to continuous disclosure obligations on licensed markets. It is not clear whether the disclosures will be subject to similar exceptions as applying in the listed markets, for example for incomplete proposals.
Changes to the minimum subscription safe harbour
Cabinet has succumbed to pressure from some interest groups to increase the wholesale investor safe harbour to $750,000, from the current level of $500,000. Accompanying this is a proposal that wholesale investors will need to sign certificates carrying prescribed warnings prior to investing.
The increase to the minimum subscription amount will be an irritant in the private placement market in which this exception is mostly employed. However, the practical impact of this will be ameliorated by the broader range of ‘bright line’ wholesale investor tests available under the new regime.
Of more concern is the investor attestation proposal, which could also extend to other exempt categories. This resembles the “opt out” proposal, which was (rightly) knocked out in an early round of the reform process.
Like that proposal, it would be unlikely to survive any rigorous cost-benefit scrutiny. However well-intentioned, reliance on prescribed warnings runs contrary to the apparently instinctive aversion humans have to boilerplate. That investor acknowledgements were a feature of the Blue Chip schemes is not a great advertisement for their merit or efficacy.
Other matters in the paper on disclosure include:
a limited disclosure statement for excluded employee share schemes and a warning statement for small offers
some minimal disclosure requirements for offers of quoted securities made under the “same class” exemption. There are also further rules around what debt tranches will be in the same class, and
as expected, regulatory capital products (such as subordinated debt) issued by banks will be subject to a ‘limited disclosure requirement’ under clause 25 of the First Schedule to the Bill. And cash and term PIE products issued by subsidiaries of registered banks (so long as the underlying investments of the PIE are very simple banking products) will not need a PDS or be covered by the disclosure requirements.
The next big step is an exposure draft of the regulations, due to arrive in spring. For submission writers digging for the enthusiasm to go one further round, the cabinet papers provide encouraging evidence that, for the most part, the consultation process is paying off with sound and balanced policy settings.
Chapman Tripp’s earlier commentaries on the Bill are available here.