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Objectives

13. In order to meet the desired outcomes and address the reasons why intervention is required, the objective of the Government's work on financial intermediaries is to ensure that:

• that intermediaries are effective and efficient in addressing information asymmetries in the market, and
• that the regime addresses the information asymmetries about the intermediaries themselves by providing the investor with confidence in the competency and integrity of their intermediary.

14. This means:

• ensuring 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, expertise and integrity to effectively match an investor 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;
• the promotion of a sound and efficient financial sector in which the public have confidence in the professionalism and integrity of intermediaries;
• regulation that is well targeted and does not impose unnecessary costs; and
• encouraging innovative and competitive markets.

15. These objectives will be incorporated into legislation to ensure that all parties operating in the co-regulatory environment must carry out their roles in accordance with the objectives.

16. Ministry officials will work to coordinate New Zealand regulation with Australian and international practice, where this is appropriate.

Assessment of Current Regulatory Regime against Objectives

17. The current regulatory regime is inconsistent across the different types of financial intermediaries and has limited overall coverage of financial intermediaries' activities. For example, investment advisers and brokers must comply with disclosure obligations under the Investment Advisers (Disclosure) Act 1996 but these disclosure obligations do not apply to all intermediaries.³ Sharebrokers need to apply for a licence from the District Court by demonstrating they are fit and proper persons before they can operate as a broker,⁴ but this licensing does not apply to all brokers who handle client money and property and other intermediaries, so there is no easy way for the public to determine the competency of their advisers.

18. The regulatory regime as it currently stands does not create the right incentives on financial intermediaries, nor does it address all of the problems for consumers in identifying competent intermediaries and making informed decisions about whether or not to take advice.

19. In 2004, New Zealand's regulatory regime was assessed by the International Monetary Fund (IMF) Financial Sector Assessment Program which considered New Zealand's securities regulations against the IOSCO Objectives and Principles of Securities Regulation in relation to how we regulate financial intermediaries.⁵ The resulting IMF report⁶ 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.

20. In addition, other current problems in the New Zealand intermediary industry include:

• Lack of consistent domestic standards and lack of confidence across the industry. Submissions to the earlier Taskforce work noted this, and that change was required in this industry.⁷ This was clear from responses to the Taskforce's final paper on options for change. Some 72% of respondents⁸ agreed that change was required to this industry. The main reasons for change were to increase standards, to increase consumer and industry confidence and to increase consumer investment. Some 7% of respondents did not want change and 21% made comments, but did not express a view.
• It's hard to attract younger people into the industry without a focus on professionalism.⁹
• If there is a problem with an intermediary, there is no standard dispute resolution or disciplinary process. This applies not only to intermediaries but is common across the financial sector.¹⁰
• For those intermediaries wanting to operate trans-Tasman there is currently no mutual recognition regime under which they can operate. If a regime is developed which achieves equivalent outcomes (but not with necessarily identical regulation) to the Australian regime then options like mutual recognition could be explored which would enable intermediaries to operate in both countries at low cost.

21. The Review of Financial Intermediaries is intended to address these problems.

Financial Intermediaries Taskforce

22. In 2004, the Minister of Commerce (then the Hon Margaret Wilson) appointed an independent Task Force on the Regulation of Financial Intermediaries to consider and report on the regulation of financial intermediaries in New Zealand.

23. The Task Force's terms of reference required it to consider options for reform that would ensure quality financial information and advice is provided to the public and assist New Zealanders to make the most of their savings. The Task Force's final report Confidence, Change and Opportunity was publicly released in August 2005.

24. The Task Force recommended an industry and government co-regulatory model which would allow different sectors of the financial intermediary industry to develop their own standards, dispute resolution and disciplinary procedures by forming approved professional bodies (approved professional bodies), to which certain classes of financial intermediaries ("personal financial advisers") would have to belong. The Task Force proposed that approved professional bodies would be overseen by a public regulator. (The full list of the Taskforce recommendations is at Annex Two).

Why Did the Task Force Recommend a Co-Regulatory Model?

25. The Task Force noted that there was strong support from industry stakeholders for enhanced self and/or co-regulation on the basis that the knowledge and practices of existing industry bodies could be leveraged to help address the current limitations of the existing self regulatory organisations.¹¹ Currently, industry relies on voluntary compliance with codes of ethics and disciplinary procedures, but it is difficult for industry bodies to effectively sanction poor behaviour (e.g. members can simply leave the industry body but still continue to practise) and existing industry bodies are not well set up to deal with all disciplinary matters. As well, a number of intermediaries do not belong to industry groups.

26. In addition, there was a high level of consensus across industry participants, consumer and regulatory bodies (including self regulatory bodies) that change was required and that it was unlikely to occur in the existing environment. The other options of enhanced self regulation or direct government regulation were not recommended.

27. Ministry officials note that part of the review of the regulatory frameworks is encouraging the use of different regulatory tools. The review of regulatory frameworks (announced in the 2006 Budget) will include consideration of the appropriate level of regulation or mix between self-regulation, co-regulation and state regulation.

Cabinet Approval

28. In December 2005, Cabinet agreed (in principle) to the co-regulatory model, with Ministry officials to carry out the detailed design work.¹² In particular, Cabinet agreed in principle that the co-regulatory framework should have the following features:

• that there would be industry-led approved professional bodies and a government regulator which would work together to regulate financial intermediaries;
• the government regulator would be the Securities Commission;
• financial intermediaries would be subject to enhanced disclosure obligations when providing financial advice with obligations dependent upon the class of financial intermediary;
• legislation would set a number of conduct standards for financial intermediaries;
• financial intermediaries would be subject to dispute resolution and disciplinary procedures.

29. Cabinet also directed the Ministry of Economic Development to undertake detailed design work with stakeholders on the Task Force recommendations and to report back with options, recommendations and final policy decisions regarding arrangements for financial intermediary regulation in mid/late 2006, with the intention of introducing legislation in 2007.

30. This discussion document seeks public comment on the application and content of the proposed legislation to contribute to the final policy decisions.