The whites of its eyes – more detail on the proposed FMA

Important new detail about the shape of the proposed Financial Markets Authority (FMA) is now available following the release late last week of the Cabinet paper seeking approval for the FMA and changes to KiwiSaver to be fast-tracked ahead of the broader review of securities law.

This Brief Counsel summarises the new information relating to the FMA, and evaluates the decision to fast-track its implementation.  Chapman Tripp will provide a separate commentary on the KiwiSaver changes within the next few days.

The context

Commerce Minister Simon Power announced the decision to move to an integrated market regulator at the INFINZ Awards Dinner on 28 April, and the following month appointed an Establishment Board to set the FMA's strategic direction and to develop for it a statement of intent, organisational structure, and work plan.

The Board is chaired by Simon Botherway and comprises Shelley Cave, Andrew Harmos, Neville Harris, Frank McLaughlin (of Chapman Tripp), Paula Rebstock, Bruce Sheppard, Scott St John and Mariette van Ryn.

The FMA, which will consolidate the Securities Commission with key regulatory functions of the Ministry of Economic Development and the NZX, is scheduled to come on stream at 1 February next year.  This is several months ahead of when the decisions from the securities review will be implemented.  They are not due to come into effect until the end of 2011 – and we think that timeframe is wildly optimistic.

The Treasury warned against the split timetabling, saying: “We view the risks of seeking to significantly advance the establishment of the new regulator, before a full picture of the regulatory regime it will operate within is finalised, as significant”.

The Minister acknowledged that the outcome of the review would influence the size, skill sets and even the type of leadership required of the FMA, and may require the legislation setting up the new organisation to be amended “very soon after it is passed”.  However he considered that this confusion was justified by the increased investor confidence which would flow from the early formation of the FMA.

Issues MED identifies with the current framework are:

  • fragmentation of roles and associated gaps and overlaps
  • regulators’ (un)willingness to prosecute wrongdoers and to take cases to clarify the boundaries of the law
  • the adequacy of regulators’ powers, and
  • a potential conflict of interest in NZX’s roles as operator of the exchange and maker and enforcer of the exchange’s rules.

The FMA – proposed structure

Like the Securities Commission and the Commerce Commission, the FMA will be an independent Crown entity.  It is proposed that it would have between five and nine members.  The number will be influenced by whether the Board is full-time or part-time.  If full-time, five may be feasible because fewer conflicts of interest would be likely to arise.  If part-time, a bigger membership would be needed.  Like the Securities Commission, the FMA would be able to act in divisions of three members.

Proposed functions

The functions proposed in the paper are to:

  • monitor and enforce compliance by financial service providers with the specific statutes applying to their industry
  • review securities disclosure documents and advertisements and take action where appropriate
  • facilitate financial markets by providing education, guidelines, information and warnings
  • monitor financial service providers and financial markets, and carry out and make publicly available any relevant reviews, studies and inquiries
  • cooperate and exchange confidential and non-confidential information with other law enforcement agencies, including overseas regulators
  • consider and approve rules for registered securities markets, and
  • perform specific functions imposed on it under any Act.

The FMA’s purpose statement will balance investor protection and facilitation of capital raising and the functions will prescribe a clearer focus on enforcement and a more active approach to considering disclosure documents and issuing warnings.  In addition, there will be scope for the Commerce Minister to indicate areas of policy priority through an annual letter of expectation to the Board.

Boundaries of the FMA’s role

The FMA will be responsible for enforcing:

  • the new legislation which will emerge from the securities review to replace the Securities Act and the Securities Markets Act
  • governance Acts specific to financial services (including the Unit Trusts Act, Superannuation Schemes Act and KiwiSaver Act)
  • governance, reporting and supervision Acts so far as they apply to financial service providers (particularly the Companies Act, including the Registrar’s power to ban directors, the Financial Reporting Act, the Corporations Investigation and Management Act, and the Anti-Money Laundering and Countering Financing of Terrorism Act), and
  • occupational regulation of financial service providers (including financial advisers, securities trustees and statutory supervisors and auditors).

After the finance company collapses, the Commission Chairperson has publicly expressed frustration at the Commission’s inability to pursue prosecutions for governance failings.  The power of the FMA to take action for false statements made by company officers may go some way to address the Commission’s concerns.  The broader issue of whether the FMA should have a role in enforcing breaches of director duties will be canvassed in the wider securities law review.

The FMA will not have responsibility for:

  • prudential regulation (the Reserve Bank of New Zealand Act and the Insurance (Prudential Supervision) Act)
  • laws enforced by the Commerce Commission (the Fair Trading Act and the Commerce Act)
  • laws enforced by MED (company and other governance laws for non-financial service providers, insolvency and personal property securities laws)
  • registrar and associated functions under any of the relevant Acts
  • Takeovers Code compliance, and
  • occupational regulation of professions involved in the provision of financial services (lawyers, accountants, tax agents and real estate agents).

The Minister may request the FMA to report on a specific issue within a stated timeframe but must consult the FMA before requesting such a review.  This power would not extend to an ability to require an investigation into whether a particular financial service provider has broken the law.  This could lead to an unhealthy politicisation and there is no evidence currently of regulators failing to pursue legitimate matters raised by the Minister for their consideration.

The FMA’s investigative tools will include the power to inspect documents, receive evidence and accept undertakings (all subject to rights of appeal).  It is also proposed that it will have search warrant powers.

Offer document vetting and Register of Securities

To align our document vetting processes more closely with Australia’s, the Government is proposing to establish a Registrar of Securities who will:

  • receive prospectuses and ensure that the required documentation has been fully completed
  • ensure the accuracy and completeness of the new internet based Register of Securities, and
  • advise the FMA of each new prospectus lodged.

It is not proposed to carry over the Registrar of Companies’ current power to decide whether or not a prospectus is false or misleading, and to decline to accept a prospectus for registration.  Nor would the FMA pre-vet prospectuses for compliance ahead of lodgement.

Instead, as with the approach in Australia, it is proposed that the FMA will monitor and review lodged disclosure documents, proactively use suspension and cancellation powers, and will have a new power to delay or prohibit allotments where it considers documents are defective.  A dedicated time during which no allotments can be made will be provided for this procedure.  In Australia, the period is seven days with an ability to extend by a further seven days on notice. 

Necessarily, the regulator will need to prioritise and risk-weight which types of documents get reviewed in the seven day period so it is conceivable that some documents will not be reviewed at all.  Under the current system all prospectuses are pre-vetted to some degree.

We consider that this is one area where redefinition of the regulator’s role (in reviewing offer documents for compliance) seems to have got ahead of the redefinition of the core securities law, and that it would be preferable to carry forward the current pre-vetting regime (to the FMA, if necessary with enhanced powers to its stop orders) rather than prematurely adopting the Australian model.

Electronic Register

More detail is also provided in the paper on the new electronic Register.  This technology will enable the public to search for and access information about securities and securities offers and will facilitate third party providers who wish to repackage data from the Register.

It is unclear whether issuer’s investment statements, or alternative offering documents required by Securities Act exemption notices, will need to be lodged on the Register.  If these documents do not require lodgement, the objective of establishing a centralised place for investors to compare offers may be only partly achieved.

Designation and exemptions

Proposals to improve the designation and exemption regime are expected to emerge from the review of securities law.  In the meantime, the Minister proposes that:

  • the scope of statutory exemptions be susceptible to limitation by regulation
  • individual exemptions be made by the FMA
  • the FMA be able to make class exemptions for periods of up to one year after which they would lapse unless the Minister recommends they be regulated for, and
  • longer term class exemptions be made by regulation only and only on the recommendation of the Minister after consulting with the FMA.

In our view, most of these changes should await the outcome of the review of securities law.  The changes to limit the scope and duration of FMA exemptions seem to have been motivated by a view that the current exemption regime “is used to make broad exclusions from the law, without effective oversight by the Minister”.  We disagree.  We think it provides appropriate flexibility for the Commission to apply relevant conditions of exemption to innovative offerings and to eliminate unnecessary rigidities in the application of a broadly expressed law. 

The Commission’s current practice is to provide class exemptions with expiry dates for periods of up to five years (rather than the one year limit proposed for the FMA).  We think the five year time limit more appropriate.  It allows for timely review of the continued need for the exemption, and consideration of whether the exemption should be incorporated in regulations.  It is also consistent with the recommendations of Parliament’s Regulations Review Committee Report on its Inquiry into the use of instruments of exemption in primary legislation in September 2008. 

In our view, the experience following removal in 2002 of the Takeovers Panel’s power to make changes to the Takeovers Code (to a system in which the Minister approves the changes on the Panel’s recommendation) has inhibited prompt progress of technical improvements to the Code.  Likewise, the MED technical review of the Securities Regulations 1983 took nine years to implement from a July 2000 discussion paper until commencement of the Securities Regulations 2009.

Next steps

We hope that, after the difficulties with implementing the Financial Advisers legislation, the Minister will circulate the draft Financial Markets (Regulators and KiwiSaver) Amendment Bill for expert targeted consultation before introduction into the House.  We would support that, as we do foresee some issues with the sequencing and implementation of some of the proposals.

Our thanks to Roger Wallis for writing this Brief Counsel. For more information, please contact the lawyers featured.

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Related topics: Financial services regulation; Financial Markets Authority

Debt capital markets; Equity capital markets; Finance; Funds, KiwiSaver & superannuation; Financial services regulation

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