2014: A turning point in New Zealand financial services
Thank you for that introduction.
I recognise INFINZ as one of the most influential organisations for professionals working in financial services in New Zealand.
It’s a pleasure to address your conference – here in Auckland.
Many of you will recognise 2014 is a turning point in financial services in New Zealand.
And certainly that’s how it feels to us at the Financial Markets Authority (FMA).
By the end of the year, the Financial Markets Conduct Act(The Act) will be fully in effect.
The Act brings new standards and new regulatory obligations for many of you in this room – and imposes significantly enhanced responsibilities on us as the regulator.
And it brings new arrangements – such as clear, concise and effective disclosure in offer documents – that will benefit investors immediately. And we have had some notable early adopters.
It also brings new business opportunities.
They include easier capital-raising under certain circumstances.
Provision for new stepping stone markets, like the one NZX is establishing, for emerging firms.
And two entirely new categories of services, in peer-to-peer lending, and in crowd-funded equity.
The Act is one thing.
On its own, it’s not much more than a very large book.
And when you add it to the regulations currently being issued as well, it’s a whole library of large books.
The more important aspect is the change that will come from it over the next four to five years.
One of the driving ideas behind the new legislation was to put in one place – or as few places as possible anyway – a lot of existing regulation belonging to a number of different agencies.
And also to take a different – and more engaged and proactive approach – to the regulation of financial services.
I am no better at seeing into the future than any of you.
But there is one change I can identify – with reasonable certainty – that we will see as a result of the Act.
That is the steadily increasing focus on quality conduct – among firms and professionals in the finance sector and in capital markets.
Conduct regulation is largely new to New Zealand, at least in financial services.
It is notable that when the FMA was named, established and given its mandate, the word ‘Conduct’ did not expressly feature anywhere much.
Indeed, when I was contemplating the CE role at the FMA, this jumped out at me.
But I was pleased to see that it’s not only in the title of the Act, but it’s a central feature of the Act.
So I’ll explain – briefly – why the rewrite of New Zealand financial services law, over the last six years, has switched the regulatory focus to conduct.
Conduct matters for two reasons.
Firstly, financial services and capital markets are different to most other markets.
The products and services that many of you here sell are – effectively – risk-sharing arrangements.
The risk ranges from – say – a fixed interest retail product with a capital protected return, where the risk to the consumer is relatively low.
Through to high-risk offers. For example, an equity offer in a newly listed firm that’s breaking into new markets.
In-between, there are a range of degrees of risk, and a range of sharing arrangements, under which the provider and the investor carry different proportions of the risk.
In some products – say hybrids v the risk might vary considerably over the life of the product. And it may be very difficult to price.
Given you are in the risk-sharing business, how you conduct yourselves – for example, in providing advice, and in disclosing the nature and scale of risks – makes a big difference to outcomes.
Outcomes which generally do not become apparent for several – and indeed often – for many years.
That’s the outcomes for you.
The outcomes for the other professionals you deal with.
The outcomes for your clients.
And outcomes for the economy.
Conduct matters for a second reason.
Yes, you are all in the risk-sharing business.
And you are all also in the ‘trust’ business.
In the types of businesses you work in, trust boils down to this:
I can be sure you will do what you and I agreed we would do. Even though you might have incentives to do otherwise, to your advantage and to my cost. Given we can’t watch-over each other every day, to ensure we are both meeting the agreement, we have to trust each other – mutually – to do what we agreed.
It’s that simple.
Yes, in contracts we describe trust in much more detailed terms.
But I’ve just given you the Plain English version of ‘trust’ in finance markets.
Keep in mind that trust matters more in longer-term deals.
Given many of you are offering 20-year and 30-year investments – say in KiwiSaver funds – trust is likely to be a bigger component of the deal.
Investors have to know they can trust you over the long-run.
And trust does not involve the product providers wriggling out of moral obligations by pointing to fine print.
Here in New Zealand we are fortunate that the naked hostility towards the finance sector – so visible in some other jurisdictions – does not exist.
We have to work incredibly hard to keep it that way.
I have to.
The FMA has to.
And you have to.
Conduct and trust are proportionate.
The better the quality of conduct – so, the accuracy of your disclosure, your willingness to tell me when the nature of the risk is changing and what that means for me – the better the quality of the long-term relationship.
Trust is, as we all know, is hard-earned and easily lost and consumers are watching financial services providers very closely.
Boards, professions and governance
The regulatory focus on trust will require organisational change in financial services firms.
We need to see an increasing focus – by Boards, and senior management teams – on the quality of conduct among the firms and professionals for which they are responsible.
Many Boards will re-gear their governance, so they can reassure themselves that their firms are delivering quality conduct that at least meets the regulatory obligations and – hopefully – exceeds them.
Already – in the few months in which I have been in this job – that is one of the questions I hear most when I talk to directors and senior management of firms:
How can we provide governance that ensures our firms and professionals are conducting themselves as we expect?
Some directors go on to ask a further question.
How can we ensure our standards of conduct keep pace, both with regulation and with the expectations of consumers and investors?
Boards that ask the second question recognise we’re only at the beginning.
As consumers and investors realise that things are changing, their expectations – of quality disclosure, of good advice, of professional conduct – will inch upwards.
In turn, that will raise the pressure on firms and professionals.
In response, some firms will consciously engineer ‘quality conduct cultures’.
In those firms, the incentives and norms will ensure professionals recognise their obligations and act on them systematically.
And that the firms can steadily raise their standards to meet the expectations of investors and consumers.
The research is pretty clear.
In retail-facing industries, those firms that clearly demonstrate focus not only on what the customer will pay for, but what actually meets their needs, are the ones that succeed over the long run.
In organisations that represent and train professionals – like the ones for directors, auditors, and financial advisers – conduct will become a feature in development programmes, and in professional qualifications.
It’s no coincidence that the professional body for directors in New Zealand - the Institute of Directors – introduces mandatory professional development for its members beginning this year.
That decision, by the IOD, reflects – among other factors – the focus on the conduct of some directors in New Zealand in the last few years, including in the finance sector.
As you all know, some of that conduct fell below the legal standards of the time, and below the expectations of investors.
Many directors do a fantastic job, and are truly committed to the organisations they serve. Even though many of them are – effectively – part-time and not in executive roles.
Making consistent standards for them mandatory is critical, and I applaud the actions of the IoD – and other professional bodes – in this regard.
Regulatory mandate and risk priorities
The Financial Markets Conduct Act is bringing change for all of you.
And it’s also bringing change for us. The FMA.
The FMA started out with a modest regulatory mandate when it was established, back in 2011.
We now have a much bigger one, with the new Act giving us extensive new responsibilities.
Taking one measure alone – the number of businesses we license – we estimate four to five hundred more businesses will begin joining our regulated populations in the next few months.
That’s additional to the regulated populations where we have some form of responsibility now. They are fairly substantial already… namely:
- About 1,800 AFAs
- About 6,500 RFAs
- 45 KiwiSaver schemes
- 450 super schemes
- 140 auditors
- 30 audit firms
- 2 accredited bodies for auditors
- 57 QFEs
- A handful of new peer-to-peer lenders and new equity crowd-funding platforms
- 60 futures dealers
- Plus the NZX
Licensing is a major feature of the new regulatory environment and a change of approach in New Zealand.
In the interests of improving standards and setting expectations up front, the new Act imposes a significant requirement on us to act as a gatekeeper for those wishing to offer financial services and financial products.
And also for you, the industry, in meeting - and demonstrating that you meet – those expectations.
More broadly, given our expanded mandate and our finite resources, we’ve been asking ourselves tough questions about where we focus our attention.
Indeed, we’re close to publishing a summary of where we see the risks to our objectives and our medium-term priority areas.
In coming to those decisions, we have been assessing the areas where we think the actual or potential harm – for investors, professionals, firms, and the economy – is greatest.
In regulator-speak, that’s called a ‘harms-based’ assessment.
To put it simply, we’re identifying the areas of conduct and governance where shortcomings or misconduct would have an impact on a large number of people or firms.
Or where the impact would be large, although on a smaller number of people or firms.
Today I want to outline to you a few of the priority areas we have identified.
We’ll publish the summary – including all the priority areas – in the next few weeks.
There will be more detail then than I can provide in a speech today.
Two points to note.
In order to maximise our effectiveness:
We’re using all the types of regulation we have at our disposal, ranging from licensing through to enforcement, and all the means in-between. We recognise we can use regulation to good effect, right along the supply chain.
And we’re also consciously using the new powers we have in the Act, what we call our regulatory toolbox. Notably, some of the new powers we have been given allow us to anticipate problems, and act before they cause direct harm.
The Capital Markets Development Taskforce – back when it reported in 2009 – pointed to the need for a modern and effective financial regulator to have a full range of regulatory tools and powers at its disposal.
The lack of those – for our predecessor agencies – is substantially corrected in the new Act.
Three of the priority areas that we have identified, and that will interest you but not necessarily surprise you today are:
- Sales and advice.
- Conflicted conduct.
- Governance and tone at the top.
Let me start with sales and advice.
The risks we see – that we think have the potential to produce low-quality conduct and lesser-quality outcomes – include:
- variable quality of advice to consumers and investors. That includes in QFEs, as well as in the AFA and RFA sectors
- constraints on access to advice for consumers and investors, including in KiwiSaver decisions
- shortcomings in investors’ understanding of products.
Areas you should anticipate us focussing on – under this priority – are practices that encourage churn or switching, including in KiwiSaver and insurance… RFA and AFA conduct… and remuneration arrangements including commissions.
In the second – and connected – priority – that’s conflicted conduct – the risks we see include:
- distribution models that exacerbate conflicts
- incentives to mis-sell or churn products – including conflicted remuneration arrangements
the ability of professionals and institutions with regulatory duties to carry them out, including custodians, supervisors, and trustees
- and poor quality disclosure. Especially about fees. About risks too.
- And the need for company directors and other insiders to demonstrate that they do not put their own interests – or the interests of others – before the interests of the companies they serve and their shareholders.
Areas you should anticipate us focussing on – under this priority – are distribution models that lead to conflicted advice and that could also lead to mis-selling.
Fee-driven conduct that leads to lesser-quality outcomes for investors.
And ensuring systems that provide the proper custody of assets.
In the third priority area - governance and the setting and driving of culture and conduct within organisations – the risks we see include:
- the skills and competencies of directors in ensuring firms meet regulatory obligations
- ensuring governance - including key processes and data - that is geared to providing reassurance about conduct
- integrated ‘make, manage, and distribute’ structures
- and our ability – at the FMA – to ensure firms and professionals understand what their obligations are.
Areas you can anticipate us focussing on under this priority are us – that’s the FMA – engaging with directors so they understand our expectations, and also the FMA focussing on quality governance arrangements in funds and in firms.
For directors and senior management, I can reassure you that the FMA will shortly publish on governance.
We’ll be providing a revised set of governance principles that reflects the experience of the last few years – drawing on experience here and overseas - and recent case law and statute.
Causes and outcomes
Setting aside the detail, I’d note two things about these priorities.
Firstly, we’re equally interested in the causes as we are in outcomes.
Hence, our focus on governance, for example.
Generally, we recognise that addressing causes is more effective than remedying poor or inadequate results.
Secondly, we assessed ourselves when we set these priorities.
We recognise there’s work for the FMA to do in order for us to help you.
We won’t be standing back in areas where we realise we have to do more, or where we have to do something different.
Indeed, when all the priorities are published – in the coming weeks – you will see that we have included the FMA’s capability as a priority in itself.
Everything we publish will be 100 per cent consistent with our enforcement objectives.
Which were stated back in September, when our annual report on enforcement came out.
Set aside a big slice of the media coverage you might read about the FMA. We don’t see enforcement as the end result of regulation.
Indeed, enforcement action is often a signal that regulation has failed.
We see enforcement as one action we can take.
And we see it as part of our total game.
Aimed at the same ‘big picture’ objectives as our licensing, supervision, and compliance work.
A further priority that you will see – when we publish – is addressing investor decision-making and education.
Most of you in this room work on the supply-side.
But I think you will recognise that investor education – that’s the demand-side – is an issue in New Zealand, as it is elsewhere. In Australia, in the UK… in many countries.
As finance professionals, you can provide investors and consumers with your best advice, and ensure quality disclosure.
But, in the end, consumers and investors make the decisions.
We know we have to address the demand-side if we are going to really improve outcomes.
That includes the willingness – or lack of willingness – of New Zealanders to take professional investment advice.
Access to advice that matches the degree of needs – sometimes known as scalable advice.
And investors’ ability to make decisions that accurately reflect their risk profiles.
We have to reflect here – too – that investors have accountability to do their own research.
Heed the warnings.
To assess thoughtfully their capacity for loss.
Because assuming that if it goes wrong, it’s someone else’s fault – or that the government will somehow come to the rescue – doesn’t make for good decision-making.
New Zealand is making progress in this area, including the excellent financial literacy work led by the Commissioner for Financial Literacy and Retirement Income (the Commission).
Some of New Zealand’s online resources – like Sorted and the KiwiSaver consumer sites, including some of those provided by the big firms – are very good.
By the way, congratulations to the Commission – and many of you here in the industry – on a great Money Week two weeks ago.
I enjoyed it. It was great to sit on a panel, here in Auckland, for an hour or so – along with John Body from ANZ, Martin Hawes, and Mary Holm – and take questions from consumers and investors.
But – Money Week notwithstanding – there’s much more to do in investor education and literacy.
And for you.
Expect to hear more from the FMA, on investor resources and education, in the New Year.
Let me return to where I started today.
Indeed, let me go back further, to the first speech I gave, when I started at the FMA.
It was not far from here, at the Langham Hotel.
The day before I gave that speech – on the first of April – the fair-dealing provisions in Part 2 of the Conduct Act had taken effect.
And so had the new liability and penalty provisions in Part 8.
I outlined two roles for the FMA in that speech.
One in conduct.
And one in building confidence, for investors and firms, in New Zealand’s markets.
Confidence improves the willingness to invest.
For local investors and for offshore ones.
For retail investors and for institutional ones.
More investment means more capital.
More capital means stronger New Zealand businesses – employing more people
Businesses that are exporting and businesses that are working locally.
Seven months on, I would say again – conduct and confidence – are really one.
Conduct and confidence are a two-way contingency.
You can’t get one without the other.
That’s the opportunity we are presented with in New Zealand as we enter 2015. Financial services and capital markets where we can rely on quality conduct, in order to provide confidence for all of us.
I know that as professionals you will want to participate fully in that opportunity.