Background
5. In October 2004, under Cabinet Appointments and Honours Committee decision APH (04) 164, the Minister of Commerce appointed the Task Force to consider and report on the regulation of financial intermediaries. A "financial intermediary" is generally described as an individual or a business who markets financial products or provides financial advice (that is, advice about financial products or investments or savings decisions and choices) to members of the public. This description is likely to include a large number of individuals and businesses (including financial institutions), mortgage brokers, investment advisers and bank and insurance company employees operating in New Zealand's financial sector. The Terms of Reference of the Task Force required it to consider options for reform that would ensure quality financial information and advice is provided to the public and would assist New Zealanders to make the most of their savings. These options for reform included introducing general legal standards; a general registration scheme; restricting occupation designation to those financial intermediaries who complied with certain requirements; or introducing a licensing regime.
6. The Task Force's final report Confidence, Change and Opportunity was publicly released in August 2005. In summary, the Task Force recommended that government and industry work together to introduce a co-regulatory framework under which financial intermediaries would be subject to enhanced standards, sanctions, disclosure, dispute resolution and enforcement procedures. A full copy of the Task Force report is attached.
Task Force Recommendations
7. The Task Force recommended a co-regulatory model over the status quo (voluntary self regulation), enhanced self regulation or reliance on the state.1 This was on the basis that:
- there was a high consensus across industry participants, consumers and regulatory bodies (including self regulatory bodies) that change was required, and that it was unlikely to occur in the existing voluntary self-regulatory environment;2
- enhanced self-regulation3 may not be the most effective mechanism for ensuring that the interests of all parties (including consumers) are reflected in the operation of the regulatory system as this model still relies on sufficient cohesion within different sectors of the industry to ensure widespread voluntary inclusion within the system;4
- while direct government supervision is usually appropriate where there is sufficient similarity across an industry and/or where state responsibility is needed to give greater assurance that industry standards and administration will actually take account of the interests of all parties (including consumers). However, in relation to financial intermediaries, different sectors of the financial intermediary industry have already developed their own standards, dispute resolution and enforcement mechanisms that are appropriate to, and recognised by, different sectors, and it would make sense to utilise these in the regulation of financial intermediaries, with government involvement required only in relation to these industry bodies.
8. Particularly, the Task Force recommended that:
- Financial intermediaries should be split into different classes, with different obligations attaching to each class so that those financial intermediaries who provide personal financial advice to the public would be subject to more obligations than those intermediaries who provide factual advice, or market products to the public.5 These additional obligations would include:
- (for those who provide personal financial advice) membership of an industry-based approved professional body and listing on a register; increased disclosure obligations in relation to remuneration, potential conflicts of interest and relationships with product generators, in some cases, in addition to the disclosure obligations being considered for investment advisers and brokers under the Securities Legislation Bill (currently awaiting its second reading); and increased standards of practice to be developed by approved professional bodies in relation to skill, education, experience, and, for businesses who act as financial intermediaries, set processes and policies.
- (for all financial intermediaries) dispute resolution procedures, under which they may be liable to pay compensation, and disciplinary procedures, which may extend to appeals to the District Court.
- A statutory regulator and a Minister to provide government oversight of the industry-based approved professional bodies and their rules, with both industry and government contributing to funding the co-regulatory framework.
9. The Task Force recommendations are generally at a high level and, as the Task Force itself recognised, there is still a lot of detailed design work to be done. Importantly, the Task Force recommended that a regulatory impact analysis be undertaken after the Ministry has carried out further development work on the recommendations, as many of the specific costs will reflect the detailed design of the proposed regime (the Ministry would seek to minimise design costs where possible).6 This design work would involve Ministry consultation with potential approved professional bodies, the regulator and other stakeholders. This design phase would result in clearer policy proposals on the application of the regime, exact roles and responsibilities of financial intermediaries, approved professional bodies and the regulator, and matters such as dispute resolution, discipline and standards of practice and would set the exact parameters of the implementing legislation.
Why Regulate Financial Intermediaries?
10. New Zealand has resolved to promote high standards of regulation to maintain sound, just, efficient and sound markets under the IOSCO Objectives and Principles of Securities Regulation in relation to how we regulate financial intermediaries.7 In 2004, New Zealand's compliance with these "best practice" principles was assessed by the International Monetary Fund (IMF) Financial Sector Assessment Program. The resulting IMF report8 recommended more comprehensive regulatory oversight of [financial] intermediaries in New Zealand, through either a licensing regime, or, as a less costly option, the imposition of standards, with monitoring by the regulator. This was on the basis that not all financial intermediaries in New Zealand are subject to comprehensive standards for internal organisation and operational conduct. Regulation of financial intermediaries would help New Zealand fully implement these best practice principles.
11. Financial intermediaries also play a key role in addressing information asymmetry in the financial sector. The market will only operate efficiently if investors can make informed choices about which products or providers best suit their needs and risk levels. Investors often do not have sufficient expertise, time or information to make these choices unaided, and as information is costly to gather and share, and once released the value dissipates, markets may under-produce information. Similarly, as the benefits of developing skills to evaluate firms and products are likely to be spent once the investment is made, consumers and investors may under-invest in financial expertise. Some of the problems with information asymmetries may be resolved through the use of intermediaries which give investors reasonable assurance that the provider is being truthful and that an investment is suitable for their needs. Intermediaries should have the expertise, time and information to break down the knowledge gap between the provider and the consumer to assist in the efficient allocation of resources by matching consumers with products that best meet their needs and risk appetite.
12. Intermediaries currently have informal incentives placed on them to credibly vouch for the quality of information because their business is based on giving accurate information and they will suffer reputational and therefore economic loss if they provide misleading information or allow a provider to falsify or exaggerate information.
13. However, consumers have limited information and a limited ability to evaluate their financial intermediaries. In addition, consumers may not verify the information provided by financial intermediaries so there may only be incentives on intermediaries to do the minimum necessary to keep their client satisfied. Low entry requirements may also allow intermediaries to operate off the reputations of other intermediaries. Further, as many of the failures in the last decades have shown there may not be sufficient incentives for intermediaries to act ethically or to manage conflicts of interests appropriately (e.g. auditors may act in the directors' best interest rather than that of shareholders, and financial intermediaries may recommend products based on the level of their commission rather than investor or consumer need).
14. The Review of Financial Intermediaries, including the Task Force report and anticipated upcoming work by the Ministry, is intended to result in:
- adequate disclosure of intermediaries' conflicts of interests, fees and competency so that investors/consumers can make informed decisions about whether to use an intermediary and whether to take their advice;
- investors having intermediaries available that have the experience and expertise to effectively match an investor or consumer with products that best meet their needs and risk profile;
- intermediaries being held accountable for any advice given and that there are incentives for intermediaries to manage appropriately conflicts of interest; and
- the promotion of a sound and efficient financial sector in which the public have confidence in the professionalism and integrity of intermediaries.
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