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Brief Counsel

The FAA, DIMS and the Financial Markets Conduct Bill

19 August 2011

​The exposure draft Financial Markets Conduct Bill (the draft Bill) has some important implications for the Financial Advisers Act (FAA), in particular for discretionary investment management services (DIMS).

This Brief Counsel summarises the proposed DIMS licensee regime, and key consequential changes to the FAA and the Financial Service Providers (Registration and Dispute Resolution) 2008 (FSPA). 

The Ministry of Economic Development has specifically requested comment on the regulation of DIMS and the overlap with the FAA, saying that this is the “least developed area in the draft Bill”.1

The boundary between the draft Bill and the FAA

The “boundary” between who is permitted to provide DIMS under the FAA and the “DIMS licensee” concept under the draft Bill has not yet been fully drafted.  Instead, there is a series of notes in the Bill and the accompanying Request for Submissions and Commentary explaining the intended approach, as summarised in the table below.

​Service type Category of products under FAA​ Provide under FAA?​ Provide as DIMS licenssee?​
Non-personalised (class) DIMS provided to a retail clients (e.g. a portfolio programme offered to all-comers but not tailored to individual circumstances)​ Category 1


Category 2
No longer permitted


Yes - can continue to be provided by AFAs, QFE advisers, registered individuals, registered entities and exempt providers (except overseas financial advisers)  ​
Must be DIMS licensee

Yes
Personalised DIMS provided to retail clients Category 1 or unlimited investment mandate

Category 2
Yes – can continue to be provided by AFAs (or QFE advisers if investment mandate limited to QFE products)


Yes – can continue to be provided by AFAs, QFE advisers and registered individuals  ​
Yes




Yes
DIMS provided to wholesale clients Any​ Yes – can continue to be provided by AFAs, QFE advisers, registered individuals, registered entities and exempt providers​ Yes​

Apart from “class DIMS” on category 1 products, it would appear that DIMS providers will be able to choose whether to obtain a DIMS licence, or continue providing those services under the FAA (assuming they are permitted to do so).  Persons exempted under the FAA will also be exempt from the requirement to be a DIMS licensee (subject to the FMA's designation power).

While on first impressions this may allow DIMS providers to elect the most favourable regime, MED signals that the FAA will be amended so that many (but not all) of the obligations on a DIMS licensee under the draft Bill will apply similarly to providers of DIMS under the FAA (more detail on these obligations is set out below).  This should reduce the prospect of “regulatory arbitrage” for DIMS providers.

Criteria for DIMS licensee

In common with any person applying for any other “market services licence”, an applicant for a DIMS licence under the draft Bill must satisfy the FMA that:

  • it is a fit and proper person
  • it meets any prescribed eligibility criteria
  • its directors and senior managers satisfy any prescribed requirements
  • it is capable of performing the service
  • there is no reason to believe that it cannot comply with its licence obligations, and
  • it is registered under the FSPA (or is qualified to be).

A licence may be granted on the basis that it also applies to subsidiaries of the licensee. 

Conditions may apply

Conditions attached to the licence may include conditions prescribed by regulation, and conditions imposed by the FMA which:
  • impose limits or restrictions on the services covered by the licence (for example, by  reference to particular financial products or issuers)
  • relate to the criteria for granting of a licence described above (for example, a requirement to continue to satisfy those criteria and verify that satisfaction), and
  • specify the expiry date of the licence, if any. 

Monitoring and enforcement

A DIMS licensee is also subject to the monitoring and enforcement provisions of the draft Bill, including:

  • reporting to the FMA at prescribed times or on the occurrence of prescribed events, and
  • reporting licence breaches or material changes of circumstance to the FMA.

The FMA has various powers in the event of licence breaches or material changes in circumstance, including censuring or issuing a direction to the licensee, or requiring the licensee to submit an action plan which, once accepted by the FMA, must be implemented by the licensee.  In more serious circumstances the FMA may cancel the licence.

DIMS licensee duties

A DIMS licensee must:

  • act honestly in providing a discretionary investment management service
  • provide the service in accordance with the client agreement/investment mandate (see below) and any subsequent instruction from a retail investor
  • act in the best interests of investors using the service and treat those investors equitably (in the case of class DIMS), and act in the best interests of the particular investor (in the case of personalised DIMS)
  • not make use of information acquired through being the DIMS licensee to gain an improper advantage for itself or anyone else or cause detriment to an investor (this requirement extends to the directors and senior managers of a DIMS licensee), and 
  • exercise the care, diligence and skill that a prudent person engaged in the profession would exercise in the same circumstances.

In addition, there are limitations on indemnities which can be provided in favour of a DIMS licensee by any retail investor who pays fees to that DIMS licensee.  Any such indemnities must be set out in the client agreement and must only be available in relation to the “proper performance” of a DIMS licensee’s duties.  

Ongoing obligations on DIMS licensees

The draft Bill also provides that a DIMS licensee must:

  • give disclosure to retail investors, much of the detail of which will be set out in regulations, before an investment authority is granted and also on an ongoing basis on request, at the prescribed time or on the occurrence of prescribed events (further details of which again will be provided in regulations)  
  • have a written client agreement with each retail investor to whom it provides services, which must provide adequately for matters to be prescribed by regulations and will have implied into it the provisions required under the Act.  Amendments to a client agreement will only be valid if they are made with the prior written consent of the investor – meaning providers will no longer be able to rely on “unilateral” amendment clauses allowing amendments simply by notice to a client
  • in addition to a client agreement, have a written investment mandate with each retail investor which provides adequately for the scope of the investment authority, including the limits on the nature and type of investments, the limits on the proportion of each type of asset invested in and the methodology for developing, amending and measuring the investment strategy (and while an investment authority can be unlimited, the investment mandate must expressly say so)  
  • report any “limit breaks” - a breach of any of the limits in the investment mandate – to the FMA, and  
  • not enter into related party transactions, unless they are on arms-length terms, are acquisitions or disposals of managed investment products in a registered scheme or other schemes recognised under regulations, or are otherwise prescribed.

Independent custodian requirement

If investor property is held on behalf of a retail investor under a discretionary investment management service, the DIMS licensee must ensure that the property is held by a custodian meeting prescribed criteria.  That custodian must not be same person as, or associated with, the DIMS licensee (unless the licence permits otherwise) – which presents a potential impediment to DIMS providers who have associated custodians.

A custodian is also specifically deemed to be a broker for the purposes of FAA, with all the provisions of the FAA applying to the holding of client money and client property also applying to the holding of investor property under the proposed Bill.

Enhanced FAA duties

Although the provisions themselves have not yet been drafted, the draft Bill signals that, of the above items, the following will apply in some form to DIMS providers under the FAA:

  • DIMS licensee duties (both wholesale and retail clients)
  • “service” disclosure requirements (which may be combined with FAA disclosure), but no ongoing disclosure requirements (retail clients only)
  • the requirement for an investment mandate which clearly states whether it is unlimited or how it is limited, but there will be no regulated client agreements or limit break reporting requirements (retail clients only) 
  • a requirement for an external custodian, although it is unclear whether that custodian can be associated with the DIMS provider (retail clients only), and
  • a duty not to make improper use of information, but no specific related-party transaction restrictions.

In addition, the FAA will be extended to cover financial advice on whether to obtain or withdraw from a DIMS service (which will be treated as financial advice on a category 1 product, if the DIMS is unlimited or covers any category 1 product; otherwise it will be treated as financial advice on a category 2 product).

Key consequential changes

The draft Bill makes a number of logical consequential changes to the FAA and the FSPA, including:

  • aligning terminology (for example, by replacing the reference to “security” in the definition of category 1 product with a reference to “FMCA financial product”, which covers the new categories of equity security, debt security, managed investment product and derivative)
  • aligning the definition of “wholesale client” in the FAA/FSPA with the definition of “wholesale investor” under the draft Bill, with the result that the categories of persons who are wholesale clients under the FAA/FSPA will be more certain (this should be welcomed by the financial adviser industry)
  • aligning the exemptions in the FAA/FSPA with the new terminology in the draft Bill (for example, the existing exemption for authorised futures dealers will be replaced by an exemption for licensed derivates issuers), and
  • specifically requiring market service licensees, custodians and licensed market operators to be registered under the FSPA.

This Brief Counsel is one of a series of subject specific commentaries Chapman Tripp is preparing on the Bill.  Links to the others are provided below:

Not for the faint-hearted: 400 page draft Financial Markets Conduct Bill 

New regime for managed investment schemes in draft Financial Markets Conduct Bill

For further information or prompt assistance with making a submission on the draft Bill, please contact any of the specialists listed.

Footnote

  1. MED Financial Markets Conduct Bill Exposure Draft, request for submissions and commentary, August 2011, page 6

Contacts