Financial Law Insight - A spoonful of sugar to help the CoFI go down

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Last month MBIE released two Consultation Papers relating to the Financial Markets (Conduct of Institutions) Amendment Bill – or as it’s known, the CoFI regime. One of those Consultation Papers is mechanical, outlining proposed supporting regulations for the new conduct licensing regime. The second is more conceptual, exploring the scope of the new regime and the extent to which it overlaps with the new licensing regime for financial advice providers.

In this Financial Law Insight, we unpack the key issues raised in the two Consultation Papers. Three issues in particular – the level of prescription for fair conduct programmes, the regulation of sales incentives, and the treatment of intermediaries under the new regime – are absolutely critical to the success (or otherwise) of the new regime.

Just how hard a pill the CoFI Bill is to swallow will be determined by the outcome of this consultation process. Everyone affected by the CoFI Bill reforms should take the opportunity to provide feedback on those key issues before submissions close on 4 June 2021.

In brief:

  • The Select Committee process has already addressed many of the concerns raised with the first reading of the CoFI Bill
  • Further prescription is contemplated for fair conduct programmes
  • The regulation of sales incentives is inevitable, but the extent of any prohibition is yet to be finalised
  • The application of the CoFI reforms to intermediaries is set to be refined

CoFI in a nutshell

The CoFI Bill is a result of the FMA and RBNZ joint reviews of the conduct and culture of banks and life insurers, and the findings of the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services industry. It proposes the first-ever conduct licensing regime for banks, insurers and non-bank deposit takers (Financial Institutions), with a new fair conduct principle at its core.

We released a Financial Law Insight on the Bill at the time. We also took the opportunity to participate in the select committee process considering the first reading of the Bill. Our concerns centred around the complexity of the new regulatory regime, the risk of unintended consequences, the exacerbation of an already uneven regulatory playing field, and the prospect of consumer confusion. The interplay with the new licensing regime for financial advice providers was always going to be particularly interesting.

A number of those concerns already look to have been addressed in the Select Committee process. What, then, are the key issues that remain to be addressed through the Consultation Papers?

Proposed Regulations to support the new regime

One of our major concerns with the CoFI Bill when first introduced was the lack of precision around the ‘fair conduct principle’, and consequently the regulatory expectations of a Financial Institution’s fair conduct programme. Those concerns were largely addressed in the Select Committee’s report back, in the form of greater clarity around the requirement to treat consumers fairly, and more detail being specified for the minimum requirements of a fair conduct programme.

The first Consultation Paper asks whether or not additional regulation is required to pad out the minimum requirements for a fair conduct programme. Each limb of the proposed minimum requirements is analysed in full. In some cases the conclusion reached is that no further regulations are needed to support the requirement. In others, the option of further regulation is left open.

In our view, the appropriate balance is struck with the current set of minimum requirements specified in the Bill, without prescribing anything further. This strikes the right balance between providing Financial Institutions with certainty as to what is required, and allowing them sufficient flexibility to tailor their fair conduct programmes to meet their particular dynamics.

There is a statutory review clause imbedded in the Bill, which could be used to address any deficiencies which might become apparent once fair conduct programmes have been put into practice. Inevitably, the FMA will put its own spin on what is required, over and above anything that might be spelled out in the legislation. There seems no need to prescribe further compliance red tape.

The other key battle ground in this Consultation Paper relates to the extent to which regulations will prohibit or constrain sales incentives. It is inevitable that some regulation will be provided in the space, with Cabinet already having made a decision to prohibit sales targets based on value or volume. It is simply a question of how far the regulations should go.

The preferred option put forward in the Consultation Paper is to prohibit sales incentives that are based on volume or value targets, as opposed to a principle-based prohibition. Helpfully, there is also a list of particular types of remuneration that would not be included within the scope of the constraints, such as salary-based remuneration and linear sales incentives.

We see the decisions that are reached here as being fundamental to the future viability of the financial advice sector. There is a high risk of unintended consequences, including the risk of unintended consumer harm, with whatever route is taken. The appropriate carveout of incentive arrangements that are not caught by the regulatory constraints will be particularly important.

There is no easy answer. What is important, however, is that an open and constructive dialogue is maintained to ensure that all risks and potential consequences are clearly articulated and worked through.

The balance of the first, more mechanical of the Consultation Papers, covers:

  • the requirement to publish information about fair conduct programmes
  • calling in contracts of insurance as financial products covered by the fair dealing provisions of the Financial Markets Conduct Act
  • exclusions of certain occupations or activities from the definition of ‘intermediary’ and
  • Lloyds Insurance Market.

While each of these aspects is important in its own right, we don’t see them as being quite as significant as the level of prescription for fair conduct programmes and the regulation of sales incentives.

Options for the treatment of intermediaries under the new regime

The more far reaching of the two Consultation Papers covers the extent to which the new regime will overlap with the recently implemented licensing regime for financial advice providers.

This overlap, and the prospect of double (or even multiple) jeopardy for financial advice providers when it comes to working out their conduct obligations, was the most significant of our concerns raised in response to the CoFI Bill when first introduced. The extent of a Financial Institution’s obligations in relation to intermediaries – and those intermediaries’ obligations in relation to Financial Institution Fair Conduct Programmes – were reduced at the Select Committee stage. However, concerns over undue regulatory complexity for financial advice providers and practicalities remain.

The fact that MBIE is willing to consult further on this key issue, both in response to concerns raised and its own reservations in this regard, is a real credit to the process. The trick now is coming up with a system that strikes the right balance between financial institutions taking some responsibility for the customer outcomes provided by the distribution channels they employ, and the risk of overcooking the regulatory obligations at play.

The amendments to the CoFI Bill proposed in the Consultation Paper involve:

  • amending the proposed definition of ‘intermediary’ to capture only persons involved in the sale or distribution of captured services or products
  • narrowing the obligations that will apply to Financial Institutions in respect of intermediaries to minimise compliance costs and duplication of regulation while still ensuring Financial Institutions take appropriate responsibility for consumer outcomes.

We strongly support the right-sizing of the obligations and refinement of their scope as proposed.

Interestingly, some of what has been proposed may result in reversing out some of the changes that were implemented at the Select Committee stage, but this is not a bad thing. In our view, when experimenting with new regulation it is always better to err on the side of minimising disruption at the first instance. If the initial set of regulations turns out to be insufficient to meet the policy objectives, there is always potential to add further obligations. However, if the initial solution is over prescribed and unworkable in practice, the damage may have already been done.

Concluding thoughts

We were pleased to see a few of the themes we had pushed in our submission on the first reading of the CoFI Bill being picked up in the Select Committee process. Gaining more statutory clarity around the expectations of a fair conduct programme was particularly important.

The second of the two Consultation Papers, relating to the treatment of intermediaries under the new regime, will inform some further critical changes that will be made to the CoFI Bill before it receives its final reading. Our law-makers have to get this right. Otherwise, the challenges that some financial advice providers and distribution models will face may be insurmountable.

MBIE is to be commended for its proactive approach in consulting on both the implementation regulations and on right-sizing the scope of the new regime at this late stage. The CoFI Bill was introduced in a rush with minimal consultation, and we are now seeing the regime finessed in a more measured fashion. This is a good thing.

Financial institutions and financial advice providers have until 4 June to have their say. This is likely to be the last opportunity to do so before the regime is passed into law. We encourage everyone potentially affected by the new regime to take up that opportunity.

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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