Financial advice provider licensing - another piece of the puzzle revealed

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The FMA has signalled its intentions for the full licensing of financial advice providers (‘FAPs’) under the new regulatory regime for financial advice by releasing a consultation paper on the proposed standard conditions for those licences and classes of financial advice service. The standard licence conditions proposed provide us with one of the final pieces of the jigsaw puzzle that will make up the regulatory compliance obligations for FAPs once the new regime is finally into full swing.

In Brief:

  • The FAP licensing system proposed by the FMA involves three classes of licence and eight standard licence conditions.
  • A bouquet to the FMA for the generous six-week consultation period provided.
  • Another bouquet for the easy-to-understand approach of categorising licence classes based on the manner of advice delivery.
  • A brickbat for then labelling those licence classes A, B, and C.
  • Overall, the licence conditions look sound, but we see a few problems in practice and there’s a surprise omission.
  • The conditions form a significant piece of the compliance puzzle. Taking the time to provide meaningful feedback to the FMA is essential - you might not get another opportunity as good as this one.

In Full:

June 2020 was always going to be moving month for the regulatory regime for financial advice services being ushered in under the Financial Services Legislation Amendment Act 2019 (‘FSLAA’). 29 June was the date the regime was previously supposed to come into effect, until a certain bug closed everything down. Instead, June has brought us a consultation paper from the FMA, proposing that full FAP licence applications be channelled into three cascading groups and impose eight standard conditions on them once they get their full licence.

Hot on the heels of the release of that consultation paper, we had the long awaited disclosure regulations finalised on 22 June, along with a commencement order locking in 15 March 2021 as the go-live date for the brave new world of licensed financial advice provision.

We’ll unpack the final form of the disclosure regulations in a future Financial Law Insight – that’s another major piece of the compliance puzzle, and all the nuances that will need to be factored in when applying those regulations in practice will take some working through. For now, the sighs of relief that the regulations have finally landed will have rung loud and clear throughout the sector, with FAPs now having nearly 9 months to automate their systems to meet the new requirements.

In this Financial Law Insight, we challenge the thinking behind the new class system for full FAP licence applications, and pick out some of the key issues with the proposed standard licence conditions where we think the debate will be fiercest.

FAPs and other stakeholders have until 7 August to provide their feedback to the FMA in relation to its licensing proposal – a generous timeframe compared with many that the sector has had to manage of late. For that, the FMA is to be applauded. It’s in everyone’s interests to get the licence conditions right, and that timeframe at least allows those affected to identify any of the aspects that have been proposed that won’t work for them, and push for a different outcome. Or heaven forbid, just congratulate the FMA on a job well done... The next few weeks will tell.

Licence classes

The FMA has proposed three licence classes for FAPs: Class A, Class B and Class C. Inspirational.

Importantly, the proposed licence classes do not relate to the types of financial advice that are to be able to be provided under the relevant licence, but rather the manner in which regulated financial advice is allowed to be provided by the licence holder. We have:

  • Class A for FAPs who have just the one financial adviser providing financial advice on their behalf, or who don’t engage any financial advisers or nominated representatives to provide financial advice, but instead provide it direct on their own account.
  • Class B for FAPs who provide financial advice on their own account and/or through one or more financial advisers (but not through nominated representatives). These FAPs are able to include authorised bodies within their licence, with financial advisers able to be directly engaged by the FAP or authorised body (or with specific approval from the FMA, indirectly engaged through an interposed person).
  • Class C for FAPs wishing to provide regulated financial advice to retail clients in any manner permitted by law. This is the only class of licence that permits the engagement of nominated representatives.

Our thoughts on licence classes

The class system proposed is, somewhat counter intuitively, nothing to do with the quality or advice credentials of the FAPs who apply for each class. Rather, the classes simply go to the approach the FAP has taken in structuring its business, and how it intends to provide regulated financial advice.

We think this approach to classification of FAPs is smart. For what has become quite a complex regulatory regime, licence classification on this basis is pretty simple, and it should be straightforward for FAPs to work out which class of licence is applicable to them.

The class system proposed indicates that the FMA regards the use of nominated representatives as being an area of greatest risk, where extra care will be required to ensure that the FAP has the appropriate processes and systems in place in order to be licensed to operate such a model. At least that’s what we assume – we won’t really know until the licence application guide comes out to see the different types of questions that will be asked for each class, and how many extra hoops will need to be jumped through as you move up the class scale.

What the class system does is enable the FMA to right-size the application process, with the most streamlined option being provided for those seeking a Class A licence, through to the most invasive and detailed process that will no doubt be required for Class C licences. This is an example of the FMA ensuring the licensing process operates as efficiently as it can, taking a risk-based approach.

Our only problem with the class system outlined is in the naming convention used. Sure, the name given to each class will primarily be a behind-the-scenes thing, as an administrative matter between the FAPs and FMA. From the FMA’s perspective, the only relevant question is whether you have a licence or not. That should also be the only question that is relevant to a consumer, given that each class of licence supports all types of financial advice.

The issue is that the perception of class does matter, and consumers will be confused by what appears to be a reverse-order class system. You cannot stop the uninformed looking at a provider with a Class C licence, and query what they have done wrong or what inadequacies they have in their systems that prevented them from obtaining a Class A licence. There’s no logic to it, but that’s human nature.

We’ve been there before with poor choices of names used for regulatory concepts. It’s taken over 10 years for the ill-advised use of the term ‘broker’ under the Financial Advisers Act to finally meet its doom under FSLAA. Now it looks like history is set to repeat itself.

In our view, this class naming convention is an avoidable distraction in the FSLAA regime that should be removed. Far better, we think, to use descriptive terms for the three categories of licence, and not use the ‘class’ concept at all. What would be wrong with having a single adviser licence, a multi-adviser licence, and an unrestricted or comprehensive licence? At least then the licence name signals the manner of advice consumers are going to get from their provider based on what’s on the tin.

The proposed standard conditions

Eight standard conditions have been proposed:

  1. Record keeping
  2. Internal complaints process
  3. Regulatory returns
  4. Outsourcing
  5. Professional indemnity insurance
  6. Business continuity and technology systems
  7. Ongoing capability
  8. Notification of material changes.

As with the standard conditions that apply for transitional FAP licences, each condition is set out in the form of the headline condition, together with an explanatory note providing some practical guidance as to what the FMA is expecting. The consultation paper released by the FMA goes further, in providing some further comments to explain the purpose of the relevant condition and put it in context.

As portrayed in the consultation paper, standard conditions are a reasonably approachable set of commandments for FAPs to abide by. They are primarily principle-based, with minimal prescription included, and an appropriate balance of detail provided in the explanatory notes. But we don’t think they are perfect.

Some issues with the conditions

Standard Conditions 1 and 2 reflect the existing transitional licence conditions, with some relatively minor adjustments made to the explanatory notes accompanying the record keeping condition.

Record keeping

The record keeping standard condition remains number one. That’s fitting, as this is perhaps the most critical condition to get right – and one of the most challenging from a practical perspective. The need to keep good records is a given. The challenge lies with what counts as adequate records in relation to a FAP’s financial advice service.

Many intended licensees are already grappling with the challenges of what records will actually be required, and how best to automate those requirements to meet the regulatory expectations. To what extent do you need to keep records of interactions where no financial advice ends up being provided? How do you deal with interactions where the client fails to identify themselves, as commonly occurs in online interactions? How much detail is required to evidence compliance with the financial advice duties?

While we don’t want to see undue prescription included in the explanatory notes for the record-keeping condition, more guidance (possibly through the licensing application guide) is required to ensure FAPs get the balance right. Otherwise, some may take an unduly minimalist approach, while others might unnecessarily go to greater lengths than are required out of an abundance of caution.

Complaints

We think the internal complaints process standard condition makes sense, and in the form presented is one we support. Sure, it will result in FAPs recording a greater number of complaints than they might otherwise have regarded as complaints if left to their own devices, but that is not a bad thing. One of the best lead indicators you can have of potentially systemic issues within your organisation is the number of complaints you receive in relation to a particular area, even if those complaints appear inconsequential.

Regulatory returns

The requirement for regulatory returns is to be expected, and is not controversial in and of itself. The difficulty with this one, as has been the case with AFA returns, will be in the level of detail required in the regulatory reporting when the time comes.

The FMA will no doubt consult with industry prior to the publication of its Regulatory Return Framework and Methodology that will flesh out the standard condition. Our plea is that the information requested does not amount to a data fishing expedition, but is limited to information that actually matters and does not impose an undue information gathering burden on FAPs.

Outsourcing, BCP and Technology

Where we see the greatest heat arising is in the outsourcing standard condition, and in the business continuity and technology systems standard condition. These are biggies. We encourage all would-be FAPs to invest the time now to think about how these conditions will be observed in practice in their business, and provide their feedback to the FMA with what they find – whether good or bad. If any aspects of these conditions don’t work in practice, we are going to have a very challenging time ahead.

PI cover

The last observation we have at this stage relates to the requirement for professional indemnity insurance. We believe that imposing this obligation on all FAPs is a problem. The FMA has confirmed that applicants who demonstrate that they are unable to obtain appropriate cover or have other valid reasons for not having cover will be able to have this standard condition waived. However, that comes with the price tag of a rather unattractive disclosure obligation.

We see this as an undue barrier to entry, given the number of FAPs for whom professional indemnity insurance will either not be available at all, or not available on acceptable commercial terms. We would rather see the position reversed with this one – professional indemnity insurance should only be required as a licence condition on a case-by-case basis, where the FMA considers it necessary in light of the FAP profile or proposition as presented.

The licence application process itself should be sufficiently robust that the FMA is able to identify where this might be appropriate. FAPs could then save themselves the pain of a more invasive application process by simply front-footing the fact that they have adequate PI cover in place.

Taking this approach will avoid making professional indemnity insurance a default requirement that is going to materially disadvantage some FAPs from participating on an even footing in the essential service of providing financial advice.

What’s missing?

We think the mix of standard conditions is about right. They are largely consistent with other market service licence conditions that currently apply under the Financial Markets Conduct Act (other than the requirement for professional indemnity insurance, which is peculiar to FAPs and which we hope will be dropped, as per the above discussion).
The surprise to us was that there was no standard condition proposed to cover a fair treatment commitment, or the adoption of a fair conduct programme.

Given that the key theme for the FMA over the past couple of years has been the demand for improvements in conduct and culture by financial markets participants, we were expecting the FMA to use FAP licensing as an opportunity to turn its expectations into a legally binding obligation. When you consider the prospect of the Financial Markets (Conduct of Institutions) Amendment Bill (or ‘CoFI Bill’) being delayed and narrowed in the course of the legislative development process, this omission is even more surprising.

Having worked with a number of providers on their submissions to the CoFI Bill, our impression is that many would actually be quite happy to adopt their own fair conduct programme and commit to treating customers fairly as part of their licence conditions. A number are already well advanced with imbedding these sorts of programmes within their businesses. By striking now, and including a fair treatment requirement that has been tailored to FAPs as part of the standard conditions, the arguments for excluding FAPs from the scope of any future financial institution conduct regime flowing from the CoFI Bill are enhanced.

Another condition we were expecting to see was a condition relating to the systems for engaging financial advisers and nominated representatives. Given that they do not otherwise have any regulatory visibility as they don’t need to be registered, the processes around appointing and keeping track of nominated representatives seem particularly important.

From the FAPs’ perspective, this omission is no doubt a good thing, ensuring they have autonomy and flexibility in how they go about engaging and keeping records of their adviser force, but we wonder if this is an aspect that might be fleshed out in the licence application guide in due course.

Final thoughts

When the consultation paper first came out, we were concerned that not having the final form of the advice disclosure requirements available would impact on the ability of stakeholders to provide fully-informed feedback on the proposed conditions.

With the disclosure regulations released early in the consultation process, that concern has fallen away. Apart from the application guide for full licensing, and the technical implementation and financial service provider regulations, all of the pieces of the jigsaw puzzle that makes up the regulatory requirements for a FAP are now on the table.

The six-week consultation period provided by the FMA presents a golden opportunity for FAPs to have meaningful input into the conditions that will govern their future operations. However, providing meaningful input requires FAPs to make sure they allow themselves enough time to fully understand the practical implications of what has been proposed, and assess how they will go about ensuring compliance within their own business model. That means this is not a piece of consultation to leave until the last minute, which can be a danger with more generous consultation periods like this one. The FMA is also very keen for submitters to get their submissions in early – 7 August is not a target date, but a drop-dead final date to get your submission in.

Some may take the view that there will surely be ample time for making changes to the conditions with full licensing not even starting until 15 March 2021, with FAPs then having up to two years to apply for an obtain a full licence. Surely there will be further opportunity to finesse the conditions?

The problem is that the conditions are only half of the equation. The other half is the licence application guide which the FMA will somehow need to develop in tandem with finalising the licence conditions. To give everyone a fair heads-up as to what the full licensing picture will look like, the FMA will no doubt want everything finalised before the end of the year, and that is what most FAPs will want as well. In order to inform the licensing application guide consultation, the FMA will need confidence that its proposed licence conditions are on the right track. We think they are, but there are a few kinks in those tracks that need to be straightened out before we get to the final destination.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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