10-11/0679 File No: P/017/PR007/001 FINANCIAL MARKETS (REGULATORS AND KIWISAVER) BILL - INITIAL BRIEFING

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1 10-11/0679 File No: P/017/PR007/001 The Chair COMMERCE SELECT COMMITTEE FINANCIAL MARKETS (REGULATORS AND KIWISAVER) BILL - INITIAL BRIEFING INTRODUCTION 1 The Financial Markets (Regulators and KiwiSaver) Bill establishes the Financial Markets Authority (FMA) and makes other changes to the functions, duties, and powers of regulatory bodies. 2 The main changes in the Bill are that: The FMA will replace the current Securities Commission, and carry out some of the current roles of the Ministry of Economic Development (in particular, the regulatory role of the Government Actuary and some of the roles of the Registrar of Companies). In addition, the Commissioner for Financial Advisers will be disestablished once the new financial adviser regulatory regime comes fully into force. The FMA will have an enhanced role in regulating registered exchanges, and the New Zealand Markets Disciplinary Tribunal (NZMDT) established by NZX will be replaced by an independent body supported by the FMA. The structure of retail KiwiSaver schemes will be changed so that the manager of the scheme is the issuer for the purposes of the Securities Act, and the trustee of the scheme would be responsible for the supervision of the manager. The trustee of the scheme will be required to be licensed under the licensing regime established by the Securities Trustees and Statutory Supervisors Bill. KiwiSaver schemes will also be required to provide quarterly reporting on scheme performance. A register for all public offers of securities will be established, with search capability that will facilitate comparison between financial products. FMA ESTABLISHMENT AND REVIEW OF SECURITIES LAW 3 Financial sector reform is one of the Government s key regulatory priorities. This work stems out of the Review of Financial Products and Providers begun in 2006, but also responds to the recent global financial crisis, New Zealand finance company failures and the recommendations of the Capital Market Development Taskforce.

2 2 4 This reform agenda has been progressed on a staged basis according to the priorities of the Government of the day: a The new regulatory regime for financial service providers was enacted in 2008 through the Financial Advisers Act and Financial Services Providers (Registration and Dispute Resolution) Act 2008; b Prudential regulation of non-bank deposit-takers was enacted in 2008 through part 5D of the Reserve Bank of New Zealand Act 1989, and a licensing regime for deposit-takers is being developed; c d e The Securities (Disclosure) Amendment Act 2009 responded to the international financial crisis by removing unnecessary impediments to capital raising, while ensuring the timely disclosure of relevant information to prospective investors; Prudential regulation of the insurance sector was enacted in 2010 under the Insurance (Prudential Supervision) Act 2010; and A new licensing regime for securities trustees and statutory supervisors has recently been reported back by this committee through the Securities Trustees and Statutory Supervisors Bill. 5 Much of the remaining reform agenda falls within the Government s review of securities law, in two parts: a b This Bill establishes the new market conduct regulator, changes the functions, duties, and powers of regulatory bodies, and introduces reforms to enhance the integrity of KiwiSaver; and The Government s June 2010 discussion paper, Review of Securities Law, proposes improvements to disclosure to investors, reviews the definition of securities, clarifies the exemptions from some of the protections of the Securities Act, rethinks the liability regime, changes the regulation of collective investment schemes, and makes a number of other changes including a rewrite of securities legislation. 6 The Government initially intended to progress all elements of the review of securities law together, but decided to bring forward the first part of that work programme for enactment in early 2011 through this Bill. The Ministry is currently reviewing 98 substantive submissions on the discussion paper and is developing policy proposals for Government. Reasons for fast-tracking 7 There is broad agreement with the proposal to create a new market conduct regulator. The desire to see regulators being more proactive, including more visible and rapid investigation and enforcement of the law, is generally shared. There is also general agreement that the regulatory regime around KiwiSaver is not as robust as it should be, and it compares poorly with international best practice.

3 3 8 Financial markets depend on trust and confidence doubts about the robustness of the regulatory regime undermine that trust and confidence, with flow-on effects for market activity. Given the broad agreement regarding the changes needed, waiting until the remainder of the work is ready risks sending a signal that the Government is not committed to making improvements in this area. Further, rushing the remainder of the review of securities law in order to ensure the regulator is established quickly would be unsatisfactory, given the significance of the changes proposed in the discussion paper. 9 Fast-tracking allows the new authority to be up and running in time to help implement subsequent changes to securities law once the full review is completed. An additional benefit is that the time between the announcement of changes and their implementation is reduced, minimising the period of time during which the existing regulators might be viewed as lame ducks by market participants. 10 The Government s judgement was that consolidation and clarity of the role of the regulator is an important step needed to improve confidence for investors. THE FINANCIAL MARKETS AUTHORITY 11 The FMA will, like the Securities Commission and the Commerce Commission, be an independent Crown entity that carries out its functions independently. This level of independence accords with international norms for securities regulators. 12 The Bill provides for the FMA to take over the current rights, duties, and obligations of the Securities Commission and the regulatory functions of the Government Actuary, and for the transfer of staff to the FMA. While the FMA will have a new board, a chief executive, and a new structure, continuity of staff limits the risk of a gap in the regulatory system while the FMA is finding its feet. 13 The board of the FMA will comprise between 5 and 9 members. In addition, the Bill provides for up to 5 associate members to be appointed in relation to a matter or class of matter. Associate members are currently used in relation to the Commerce Commission. Like the Securities Commission, the FMA will be able to operate in divisions of 3 or more members, or delegate functions in accordance with the Crown Entities Act 2004 to committees of the board or staff members. FMA s functions and duties 14 The FMA s main objective is to promote fair, efficient, and transparent financial markets. The FMA s functions include promoting the confident and informed participation of business, investors, and consumers in the financial markets by, for example, issuing warnings, reports, and guidelines, and providing or facilitating the provision of investment literacy. One of the functions is to promote awareness by investors that all investment involves risks and that it is not the role of the FMA to remove these risks.

4 4 15 The FMA will monitor compliance with, and investigate and enforce, financial market conduct legislation (principally the Securities Act 1978 and the Securities Markets Act 1988). It will also perform these functions in respect of governance, reporting, and supervision Acts so far as they apply to financial markets participants (principally the Companies Act 1993, the Financial Reporting Act 1993, the Corporations (Investigation and Management) Act 1989, and the Anti-Money Laundering and Countering Financing of Terrorism Act The FMA will regulate financial advisers, securities trustees and statutory supervisors, and auditors. 16 Since introduction of the Bill, it has come to our attention that some reworking of the concepts of financial markets participants and financial service providers may be required in order to ensure there is a clear dividing line between those institutions regulated by the Companies Office and those regulated by the FMA, and to ensure that the scope of those regulated by the FMA is appropriate and workable. Some submitters have commented on this issue. FMA s information gathering and investigation powers 17 Part 3 of the Bill sets out the FMA s information-gathering and enforcement powers which enable the FMA to carry out its functions. The powers are based on existing powers of the Securities Commission and the Commerce Commission. They will enable the FMA to require persons to supply information, produce documents, give evidence, and to co-operate with overseas regulators. The FMA will also be able to obtain search warrants, a power that the Commerce Commission has but the Securities Commission does not. 18 The need to have these types of powers is not controversial, although some submitters may comment on matters of detail. FMA s power to exercise a person s right of action 19 The FMA will have the Securities Commission s current powers to seek civil remedies under the Securities Act and the Securities Markets Act, including where a prospectus or an investment statement contains an untrue statement or where a person has engaged in misleading or deceptive conduct in relation to any dealing in securities. 20 There are, however, situations where financial market participants, auditors and other people regulated by the FMA may have acted in a manner that gives rise to a civil right of action, but the Securities Commission is unable to act. These include cases of negligence, breach of trust and breach of statutory duty (e.g. directors duties). 21 The Bill includes a new power enabling the FMA to exercise a person's civil right of action. If, as a result of an investigation or inquiry carried out by the FMA, it considers it to be in the public interest to do so, the FMA may exercise the right of action of a person by commencing and controlling certain types of civil proceedings against financial markets participants and certain other specified persons, or by taking over existing proceedings.

5 5 22 The person whose right of action is being exercised will have an opportunity to object, and if the person does so, the FMA will need to obtain the leave of the High Court before exercising the power. Leave of the High Court is also required before the FMA may take over existing proceedings. 23 The Australian Securities and Investment Commission (ASIC) has a similar power under section 50 of its Act, and this power has existed in Australia in one form or another since the 1950s. Under the new power, the FMA may, in the public interest, take civil actions that benefit investors in a wide set of circumstances. For example, it could enforce directors duties on behalf of a company or its shareholders, or take an action in negligence against a company s auditor. 24 It is rarely in the interests of individual investors to act in these cases because of the costs and risks involved or, in the case of debenture holders, because they have limited legal standing. Further, in the case of closely held companies, the company and its shareholders may not have the right incentives to bring an action against directors. This is likely to have been the case with a number of finance companies, for example. 25 The power does not change the duties or liability of any person: its sole effect is to give the FMA standing to take up existing rights of action against certain persons and in certain circumstances. Its primary objective is to promote the public interest rather than to obtain redress for investors, although redress (for example, damages) would often follow if the FMA s action were successful. 26 In assessing whether it is in the public interest to take action, the FMA will have to consider certain matters. These include the FMA s objective of promoting fair, efficient, and transparent markets, the likely effect of proceedings on future conduct, the effective and efficient use of its resources, the significance of the matter, and whether the action would be taken if the FMA did not act. As a result, it is expected that the FMA will exercise the power infrequently. 27 A number of submitters have commented on this power. Costs and benefits 28 The power responds to a collective action and incentive issue which can lead to under-enforcement of things like directors' duties, which leads to the risk that the unscrupulous can take the risk that a breach of, for example, the duty to act in the best interests of a company will not be enforced, because the people who have a right of action do not have the incentives or resources to take the action. 29 There is clearly a public interest in the FMA taking an action if failure to do so might have a detrimental effect on confidence in New Zealand s securities markets, or if taking civil action would contribute to the FMA s objective of promoting fair, efficient, and transparent financial markets. Other benefits include improved corporate governance and increasing the efficiency of enforcement.

6 6 30 A key risk of the proposal is the potential affects on directors willingness to serve, due to the increase likelihood of civil cases being taken against them. Some submitters have commented that it may make directors more risk averse. It is unclear whether this risk is significant, but it is notable that the power does not establish any new duties or penalties. 31 Some submitters are also concerned that the FMA may have poorly aligned incentives in relation to enforcement of directors duties, and may take too many actions that are not material or lack merit, that the FMA may lack required resources and expertise, and that action would not be an efficient use of FMA resources. The FMA s ability to take action is based on the public interest, which will help to mitigate these risks. FMA s powers relating to warnings 32 The Bill provides for the FMA to issue warnings about any matter relating to financial markets or financial markets participants. The FMA would usually publish the warning on its website and issue a media statement, as the Securities Commission currently does. Typical warnings issued by the Securities Commission cover matters such as offers of securities made without a registered prospectus or investment statement, and unsolicited offers to buy securities for below their market value. 33 In some cases, however, these warnings are unlikely to reach their intended audience. Investors do not commonly check the Securities Commission s website before each transaction, and only the more newsworthy warnings receive significant media coverage. 34 The Bill therefore enables the FMA to require its warning to be published by certain persons to whom the warning relates. The power is limited to requiring the warning to be published on the person s website, or for it to be included in, or accompany, any offer document or other statutory disclosure document, such as a financial adviser s disclosure statement. Ability to fund the FMA through levies 35 Part 4 provides for a new levy of financial markets participants to part fund the work of the FMA. The proportion funded by market participants will be determined by budget appropriations following consultation with industry, and the model for allocation of the levy among participants will be prescribed in regulations. 36 At present the regulators are funded by a mixture of cost recovery regulatory fees and Crown funding. The new financial advisers regime provides for the Securities Commission to be levy funded. Changes to the Securities Act Part 5 of the Bill amends the Securities Act 1978, which regulates offers of securities to the public.

7 7 Scope of statutory exemptions 38 The Bill provides for the scope of some statutory exemptions to be limited by regulations. Some offers of interests or rights that would otherwise be securities are exempted from the Act, such as most estates or interests in land. This exemption has been misused by certain investment schemes, most notably Blue Chip. The new power will reduce the risk of these schemes avoiding compliance with securities laws in the future. 39 This power is not controversial. Prospectus registration process 40 The Bill also provides for a new registration process for securities offers and a new securities register. Under a new post-registration consideration process, the FMA will have the function to consider whether prospectuses contain all the required information are false or misleading. This replaces the current pre-vetting process, under which the Registrar of Companies considers each prospectus for compliance with the Act prior to registration. 41 Like the Australian Securities and Investments Commission, the FMA will apply a risk-based assessment to determine which documents it will consider in detail. No allotment may be made within a short (usually 5 working day) consideration period, and the FMA will be able to stop allotment on an interim basis and have the power to prohibit allotment for a further period or deregister a prospectus. 42 The Bill limits the Registrar s functions to carrying out basic registration functions in relation to the documents. It is more efficient for the FMA to undertake any check of completeness as part of its wider consideration of documents rather than the Registrar. 43 The Bill includes a specific offence for an issuer who knows or ought reasonably to know that a prospectus delivered on its behalf does not meet the registration requirements in the Act and regulations. This penalty will be moderate ($30,000 fine) and will fall on the issuer (i.e. the company), rather than personally on the directors. The purpose of the offence is to ensure that issuers take responsibility for ensuring that documents delivered for registration comply with the Act, but without resulting in excessive riskminimising behaviour by directors. 44 A number of submitters have concerns about the workability of the new process, particularly in relation to continuous issuers who must renew their prospectus around every 18 months. Submitters argue that the addition of a 5-day exposure period without pre-vetting creates timing complexity and uncertainty, and therefore increases cost.

8 8 45 Officials note that a new process is an almost inevitable consequence of the consolidation of the Registrar of Companies regulatory functions into the FMA. The proposed process is preferable to the main alternative which would be to have the FMA replicate the Registrar s current pre-vetting process: a b Post-registration consideration reduces moral hazard - the current preregistration process involves the regulator approving the prospectus for registration. This implies that the regulator has determined that the prospectus complies with the law and does not contain false or misleading statements. In fact, the current pre-vetting results in no such assurance to the public, as the scope of Registrar s review is relatively narrow and resources are limited. Pre-vetting by the FMA would result in it having difficulty subsequently arguing that the prospectus was false or misleading, as it would have already determined that it was not. In any proceedings, the FMA would have to demonstrate that it was wrong to have registered the document, and the defendant would be likely to focus on that initial consideration. The current process (just) works because the pre-registration role falls on a different regulator. c Post-registration consideration makes it clear that it is the responsibility of the issuer and its directors to comply with the law. The regulator can help the issuer through the process by issuing guidance, but it is up the issuer to get it right. d Post-registration consideration should result in more efficient and effective use of resources, as the regulator will be incentivised to focus on higher risk areas, and may decide not to review lower risk areas. Further, the regulator's consideration will not be limited to specific matters and so can be broader than the current pre-vetting process. 46 There may, however, be a case for relaxing the consideration period in the case of continuous issuers, on the basis that renewal could be argued to be lower risk that new offers. Officials intend to include further advice on this issue in the departmental report, but there are a number of options: a b The FMA could issue guidance to the effect that it will exercise its power to shorten the consideration period in respect of prospectus renewals for continuous issuers. The Bill contains a power that would enable the FMA to do this. The FMA could issue a class exemption that exempted prospectus renewals for continuous issuers from the prohibition on allotment during the consideration period or from the consideration period. The Bill contains a power that would enable the FMA to do this.

9 9 c The Bill could be amended to include a statutory exemption for continuous issuers in the case of prospectus renewals. The exact scope of the exemption (i.e. whether it would apply to renewals for all types of securities) would need to be carefully considered, as unlike the previous two options, it would be very difficult to change. Register of Securities 47 The Bill also provides for the Registrar to keep a Register of Securities, which has the following purposes: a b c d to give public notice of offers of securities made under registered prospectuses; to enable any person to obtain information contained in, or relating to, registered prospectuses, and to compare information about offers; to assist persons in making investment decisions and in providing financial advice; and to assist any person in the performance or exercise of any functions, powers, or duties under any enactment. 48 The new Register of Securities is intended to replace the current practice of offering documents being mainly lodged in the Companies Office record of the relevant issuer, for which there is no effective search ability. The register provisions are likely to be brought into force after the FMA is established as it will take time to build the IT platform for the new register. Periodic disclosure 49 A new power to make regulations prescribing periodic disclosure requirements is inserted into the Securities Act It is anticipated that this power will be first used to require retail KiwiSaver schemes to publicly report returns, fees, and asset allocations in a prescribed manner on a quarterly basis. This change ensures information provided to the public on those matters is consistent and comparable across schemes. The Government is considering releasing a discussion paper seeking views on proposals for standardised reporting. Changes to the Securities Markets Act Part 6 of the Bill amends the Securities Markets Act 1988, which regulates trading in securities, such as through registered exchanges (currently only NZX Limited). These changes are intended to reduce perceived conflicts of interest between commercial and regulatory functions of the registered exchange and to clarify the relationship between the FMA, the Minister, and registered exchanges, and between rules made by the exchange under contract and the law. The following changes are made:

10 10 the process for approving rules of registered exchanges will move from the Minister to the FMA. The FMA will also have the power to request rules on certain matters; registered exchanges will still enforce their own rules; a new power will be inserted to enable market integrity regulations to be made, which may replace or override exchange rules and be enforced by the FMA. Regulations will be made by Order in Council (not by the FMA); the FMA will have a formal oversight role in relation to registered exchanges. Registered exchanges will be given a general statutory obligation to operate fair, orderly, and transparent markets and perform certain other obligations. The FMA must carry out an annual oversight review of the exchange's performance against those obligations, and report the results of that review to the Minister. The FMA will have the power to require a registered exchange to submit an action plan (to be agreed with the FMA) if it considers that the exchange is failing to meet any of the general statutory obligations. Ultimately, the Minister may give a direction to the exchange if no action plan can be agreed; and a statutory Rulings Panel will be established to consider breaches of, and review decisions under, rules of registered exchanges and market integrity regulations. It will replace the tribunal established under NZX Limited s rules (the New Zealand Markets Disciplinary Tribunal). It is important that a specialist body that has expert knowledge of the market and that can adjudicate on market conduct issues under the rules quickly and with relative finality is retained. For this reason, the statutory Rulings Panel's powers and procedures will be based on the New Zealand Markets Disciplinary Tribunal's powers and procedures under the rules, with adjustments to reflect the Panel's statutory status. Changes to the KiwiSaver Act Part 7 of the Bill amends the KiwiSaver Act Under the changes, KiwiSaver schemes other than certain employer and other restricted-entry schemes will be required to have A manager who is responsible, among other things, for offering interests in the scheme and managing scheme investments and property. The manager (rather than the trustee) will be the issuer of the scheme for the purposes of the Securities Act A trustee, whose main function will be to supervise the manager s performance of its functions.

11 11 52 These changes will align the law with the current structure of the affected KiwiSaver schemes: while the KiwiSaver Act 2006 imposes almost all obligations on the trustees of the scheme, the trustees uniformly appoint or delegate these functions to a manager who is the public face and promoter of the scheme, while the trustees act as the supervisor of the manager. This contrasts with the restricted-entry schemes, in which trustees have a more hands-on role. 53 The changes will enable trustees of these KiwiSaver schemes to be brought within the trustee licensing regime provided for in the Securities Trustees and Statutory Supervisors Bill, which the Committee has now reported back to the House. Once that Bill is enacted, it is intended that a provision will be inserted into this Bill that requires the trustee of a KiwiSaver scheme other than a restricted-entry scheme to be licensed under that regime. Amendments to provide for the licensing of KiwiSaver trustees would also be made to the trustee licensing regime. 54 The Bill provides that the new governance model applies to all schemes other than the existing employer and other restricted schemes that are listed in the schedule. Any new KiwiSaver scheme will need to adhere to the new (preferred) governance model. The listed schemes can continue to operate and take new members under the current model, provided that they continue to operate as restricted entry schemes. The Bill does not provide for new schemes to become listed. 55 The Bill also removes the ability of superannuation schemes registered under the Superannuation Schemes Act 1989 to convert to, or bolt-on a KiwiSaver scheme. These provisions were included in the KiwiSaver Act to facilitate the transition to KiwiSaver, and are no longer needed. As this part of the Bill will not come into force for some time, the option will remain available for any schemes currently contemplating using this process. 56 This Part of the Bill is not expected to be brought into force until the Securities Trustees and Statutory Supervisors Bill is enacted and fully operational, which is currently expected to be mid to late Submitters are largely supportive of these changes, as they ensure the law aligns with the shape of the industry. Some amendments are likely to be necessary to tidy-up some matters raised by submitters and noticed by officials, such as to facilitate a smooth transition for schemes that need to comply with the new rules. 58 We will also advise you on adjustments to provisions around information sharing between the FMA and the IRD. The Government Actuary raised this issue in the KiwiSaver annual report that was recently tabled in Parliament.

12 12 Commissioner for Financial Advisers 59 The Financial Advisers Act provides for the Securities Commission to have a Commissioner for Financial Advisers (CFA). The role of the CFA is: to appoint members of the code committee; to review the code of professional conduct for financial advisers and propose changes to the code as required; to act as chairperson of the financial advisers disciplinary committee; and to exercise and perform such other functions, powers, and duties as are conferred or imposed on the Commissioner by or under the Financial Advisers Act 2008 or any other enactment. 60 Part 8 of the Bill provides for the disestablishment of the office of the Commissioner for Financial Advisers. The Financial Advisers Act 2008 currently provides that the Commissioner is a member of the Securities Commission. It is expected that the board of the FMA will be a non-executive, part-time board. However, the role of the Commissioner is a full-time position and so is inconsistent with the expected governance model of the FMA. 61 The Commissioner has, however, an important role in providing leadership in the setting up of the new financial advisers regime under the Financial Advisers Act 2008 during 2011, and in ensuring it is running smoothly over the following months. The Government's intention is that the Commissioner will be a member of the board of the FMA upon its establishment, and that this Part of the Bill will not come into force before late Upon disestablishment of the office of the Commissioner, the main functions of the Commissioner (who will at that time be a member of the FMA) will become functions of the FMA.