19 May 2011

Presentation by Sean Hughes to the Professional Advisers Association Conference

Thank you for inviting me to speak today. It's a great pleasure to be here.

Some of you may have seen the TV3 news story last weekend about the Bernard Whimp judgment.

While I'm obviously pleased we were able to take swift action and achieved a successful result, what struck me about the way they put the story together were the brief interviews they did with the young people on the street.

The first young guy they spoke to recognised the NZX - it's a porn magazine apparently.

Another couple were asked what a dividend was. "I've heard of it", said the young woman, "but I don't really know what it is".

I was interviewed, and advised people yet again to take advice. But what I couldn't say - what I didn't feel inclined to say yet -was get that advice from a financial adviser.

Over the last few years, 1.7 million New Zealanders have joined a KiwiSaver scheme. You'd think that alone would have led to increase in understanding of capital markets.

But what those young people demonstrated, and what the mostly older people who got duped by Bernard Whimp's offers showed is that investor literacy in New Zealand is pitiful. Seeking advice about money should be something all New Zealanders do, but instead we also see usage of financial advisers continuing to drop - from 10% of New Zealanders to 7% according to the latest RaboDirect Financial Confidence Survey.

So when I see real people unable to even hazard a guess at what a dividend is, when I see older people so nervous of 'share offers' that they'll not even read the accompanying explanations, it reinforces for me again the value of regulation.

Because if by regulating financial advisers, we can restore some of that confidence in using them, if we can get ordinary New Zealanders recognising that getting advice is a good thing to do -and that it's even better if it's from a qualified, monitored adviser, then we'll have started to achieve what the Government has set out for our organisation.

Our establishment legislation, the Financial Markets Authority Act 2011, set up FMA as a new financial sector 'umbrella regulator'.

Our main objective is to promote and facilitate fair, efficient and transparent markets. We have enhanced powers of regulation and enforcement, including important changes to the governance of KiwiSaver schemes. We oversee registered securities exchanges and we're responsible for the regulation of financial advisers and financial service providers. We will add trustees and statutory supervisors to that list on 1 October, and auditors from 1 July next year.

Over the past 20 years, while working in financial markets risk management, enforcement, and litigation, most recently for ASIC, the Australian securities regulator, I've heard of lots of analogies for the role of regulators. They've been likened to an ambulance at the top of the cliff - and an ambulance at thebottom of the cliff! They've also been likened to an air traffic controller and to a sheriff…

But I like to think of us as sports coach and referee. We help the players understand the rules so they know how to play the game safely, and we check to see they're playing by the rules. When there is foul play, we put up the red flag and send the player off the field. If their conduct is so out-of-line, we'll advocate for a season ban. We're constantly analysing the play, and we advise the national body on how the rules might be changed in order to improve the way the game is played.

At FMA, we are focused on ensuring there is a level playing field, and that the risks are obvious to all who enter the arena.

The reality is that capital markets are risky. And not everyone is careful. Companies do fail and investors do get hurt. Creditors are left unpaid. Employees are exposed and vulnerable. That's the nature of capital markets. Through good market regulation and oversight, we might be able to reduce the chances of this happening, but we cannot prevent it nor will we. That is not the role of a regulator in a developed market economy and nor should it be.

It is not our job to provide a capital guarantee for failed investment outcomes or flawed investor decisions. I reject any assertion that regulators are there to guarantee survival. There will always be an element of risk in securities market participation and this will never change despite all the regulation, close supervision, powers and resources in the world. Risk-taking, in the right circumstances and with the right resources and controls, is appropriate and I encourage it as an enabler of capital growth.

I am not, however, an advocate of the efficient markets theory of minimalist regulator. When a company hits the wall because its directors and management have been asleep at the wheel - or worse, because they've bailed out the door and let their investors take the impact - then we will look to see what action FMA can take. We will and are taking action.

In recent years, as you all will know, confidence in the financial sector has been sorely tested by the Global Financial Crisis and further damaged in New Zealand by a number of serious corporate collapses.

In particular, around 60 finance industry companies have gone under or arranged moratoria in the last five years, putting at risk $8.5 billion of investors' money. In the wake of these events, investigations into allegations of false and misleading statements are ongoing, and charges have been laid against a number of directors of finance companies.

Jane Diplock, the outgoing chairman of the Securities Commission, is on record as saying these finance company collapses occurred in "a regulatory desert". Given the extent of its legislation, the Commission's role was limited to ensuring risks were properly disclosed in prospectuses, investment statements and so on, allowing investors to make their own judgements as to whether the returns being offered were worth those risks.

Clearly they were not, and the Government heeded the call for a much more integrated approach to regulating the financial sector - hence the establishment of FMA, a significantly increased budget, and the arsenal of new powers that we enjoy today.

The Government's key focus now is to restore investor confidence in New Zealand's capital markets. Where has that confidence gone?

In 1987, 26 percent of household assets were invested in New Zealand's equity markets. As at the end of 2010, that share had plummeted to just 7 percent.

The latest ASB Investor Confidence Survey reported last weekend showed that investor confidence had dropped still further in the wake of the February earthquake in Christchurch, with investors continuing to focus their investment activities on Auckland rental property and term deposits.

Let's stop the decay now. Let this moment mark the baseline from which New Zealand's flight from the capital markets halts, and begins a long, steady, permanent and sustainable improvement. Investor confidence, and understanding of the importance of asset class diversity, is absolutely critical if New Zealand is to develop the kinds of vibrant capital markets needed to attract investment in our productive industries and, in turn, to lift our economic performance.

Market participants need to be subject to clear rules so that investors can be confident that those rules will be actively and consistently enforced. Investors also need to be able to easily access relevant information about investing wisely and well.

So FMA faces some very significant challenges and I do not underestimate the scale of the task ahead. Only in March, a Morningstar global study of investor experience in 22 countries rated New Zealand last with a D-minus. The report said New Zealand scored worst because of its low rating in the key areas of disclosure as well as regulation and taxation.

Morningstar acknowledged New Zealand was moving to improve its performance with the creation of FMA and the major review of our securities law currently taking place. What this demonstrates is that the eyes and expectations of the global investment community are on New Zealand and FMA's work. And we not only have the major task of restoring investor confidence among New Zealand investors but internationally as well!

Believe me, we are very mindful of the high expectations held both by Government and of the market for our success going forward. But I welcome that challenge, and I'm eager to get things underway.

Nevertheless, FMA is still little more than two weeks old, the new FMA Board formally met for the first time only on Monday, my appointment as CE was only then ratified, and our Statement of Intent remains in draft form. But I thought I would spend a bit of time now focusing on the financial adviser front.

You've already seen our first actions and I'm very pleased that the enhanced powers we have enabled us to challenge Mr Whimp and put a stop to the misleading offers he had made.

So where are we at on the regulation of financial advisers?

Well, this week, we've authorised our first batch of AFA 'opt-ins' - those AFAs licensed for category 2 products only but who in every other way are the same as other AFAs. These advisers have made a commitment to professionalism and gone above and beyond what was expected of them for the products they sell, and I applaud their efforts.

We are on track to reach 1000 AFAs within the next couple of weeks and, for advisers who applied by 31 March, we're on track to process all the completed applications by 1 July. We anticipate that by 1 July we'll have in the region of 2,000 AFAs.

Registered Financial Advisers are not escaping our focus.

Onesimple monitoring method we've used has involved checking the advertising or website of an adviser and if they appear to be offeringa personalised financial adviser service to the public we check theFSPR register to see if they(or the company they work for in the case of QFE advisers) are on it.

While most so far have passed this basic test, what we are disturbed to see is that many RFAs are still advertising financial planning,investment advice, KiwiSaver and other services.There's no information on their website saying they intend to withdraw from those services, and nothing to indicate they're planning to apply for AFA status.

While it's not illegal yet, with less than six weeks to go, we think it's misleading at best - and I would go as far as to say, cynical and opportunistic. It's certainly well below the professional standards of client care we know financial advisers are aspiring to. Just as an advance warning to those types of advisers, you've already seen us take action on Day One as the Financial Markets Authority. We won't shirk from doing the same on Day One of the new financial adviser regime.

Of course, registration and licensing is only the first step in the new world of regulated financial advisers.

Many of you are familiar with Ross Butler, Chair of the Code Committee who has said that 'an AFA licence is just the ticket to the game. It's how you play the game that counts'.

And I know many of you are wondering how that game will be played. What is the role of the regulator? And how is the 'burden' of regulation going to impact on your business going forward?

As I said earlier, I'm passionate about effective and proactive regulation. FMA will be outward-looking and reliant on information from the market so we can deploy our resources and our armoury of enforcement tools to best effect.

Unlike Australia, we don't have a prescribed approach to advisers' businesses - so you won't see us going line by line through your Adviser Business Statement, for instance. Indeed, the principles-based nature of the Financial Advisers Act, and the Adviser Business Statement as a living, breathing guide to an adviser's business are two examples of pragmatism on this side of the Tasman that I will continue to foster.

But what I'm sure you will see is some pretty strong refereeing of the adviser game. As I noted earlier, expectations from Government are extremely high. Those of the public will also increase as we kick off a public education campaign around 1 July. Remember, with a very public tool like the Financial Service Providers Register, it's easy for the public to do at least some basic checks on an adviser. We'll be telling them to expect more from their adviser now, and giving them a clear picture of what those expectations should be - and what to do if they are not being met.

What we'll also see, and what we're already seeing in fact through the complaints process, are professional advisers keen to see a clearing out of those who have sullied the reputation of their profession.

We'll also keep an eye on the perimeter. For example, we know advisers are sensitive to the fact that the likes of lawyers and accountants got carved out. We'll be looking closely at how 'ordinary course of business' is interpreted, and expect these professions, and their professional bodies, to act conservatively and to uphold the law in full co-operation with us.

But FMA won't be on your doorstep every week. We have been granted the resources that will allow us over the next few years to put in place the framework and systems we require to be a regulator with bite. But there are potentially more than 25,000 of you (if you count QFE advisers) and likely only a little over 100 of us. So our monitoring focus will be - and needs to be - on the areas of greatest harm to investors.

One of our core new functions will be a properly resourced, strategic market intelligence function. We will use that to inform and focus our monitoring efforts.

We will also use it to shape the guidance we provide to you. While we intend to take a principles-based approach to regulation, I know that to most if not all of you, regulation is new. You can expect clear communication on what the principles are and on how we are applying the litmus tests of transparency, fairness and integrity to guide our oversight activities.

FMA isn't alone in providing guidance. We have watched as the various professional bodies have stepped up to the plate, providing resources, information and help with interpreting the rules for those who need it.

Australia's Financial Planners Association recently issued its view of what a professional association, as distinct from an industry association, might provide. Things like: acting in the public interest as opposed to the members' interest; and advocating for change for the protection of consumers rather than advancing member success - these are aspirational goals that sit well with the intent of New Zealand's financial adviser regulation.

We'd like to work closely with New Zealand's various professional bodies to help them further develop those characteristics.

Our focus will also extend to product providers.

Product providers must take responsibility for the legal compliance of their distribution channel - whether a QFE or not. It's not acceptable to say, 'They only sell my product, they're not an employee, therefore I'm not responsible for what they do'. Where is their sense of responsibility for the end client and good corporate citizenship? Wewill take a very dim view of firms who do not cover off these matters. As a minimum, firms should be checking that every adviser who sells their product is registered and, if selling category 1 product, authorised.

Product providers must also step up to ensure they provide their adviser force with the product training and tools they need to properly inform the client about the products being recommended and, most importantly, the risks associated with those products because that goes to the heart of a suitable outcome for the client.

And it's outcomes for clients that I want to end on because, at its most basic, regulation is about getting better outcomes for the people who need and use financial advice.

And, yes, we now have standards you must reach, and tools by which we'll monitor you, but FMA alone cannot improve investor confidence. What will really make the difference will be the professional care you use with your clients.

I encourage each and every one of you to act in the very best interests of your clients. Do the right thing. Take no action that might damage or tarnish your professional integrity, or the integrity of your profession. Take your disclosure obligations seriously. Get serious about your processes and systems. Write to and talk to your clients in plain English - remember some of them may not even know what the NZX is!

Most of all, don't wait till 1 July, or worse until we come calling. The time to act is right now. As PAA members, you can take a leadership position within your industry.

Remember, as an adviser, you have a responsibility to your clients but you also have a broader responsibility to the investing public and to the health of our capital markets. After all, if your clients have confidence in you and understand the information you provide, they are more likely to give you business. And that's good for you and for all of New Zealand.

I believe we can look forward to an improved public perception of the wider financial services sector and advisers. I look forward to that journey with you. And I know we will all benefit when that is the case.