New conduct rules: what do they mean for advisers?

New guidelines on how to implement the CoFI law point to it being less burdensome than initially feared.

BY ERIC FRYKBERG | PHOTO KATRINA SHANKS

Details are emerging about what the CoFI law will mean for advisers - and it seems less onerous than had been widely feared.

This appears to be the message from the Financial Markets Authority (FMA), which issued guidance in February on how to implement the new law.

In fact, according to the draft guidance document, CoFI – real name the Financial Markets (Conduct of Institutions) Amendment Act 2022 – has flexibility built into it, and allows financial institutions to make a judgement call on their own intermediaries.

“The FMA intends to take an outcomes-focused approach to supervising financial institutions,” the guidelines state.

“We believe that financial institutions know their businesses best, and are best placed to determine the most effective actions to achieve CoFI obligations and objectives.”

Financial Advice NZ chief executive Katrina Shanks says CoFI, as proposed in the FMA guidelines, will work in tandem with the Financial Services Legislation Amendment Act 2019 (FSLAA).

She says she is “pleased overall” with it.

No one-size-fits-all

Following recommendations from the FMA and the Reserve Bank, CoFI grew out of the Government's desire to impose a code of conduct on banks, insurers and non-bank deposit-takers.

The recent guidelines are particularly important to mortgage advisers, as more than half of the loans written by the big banks are originated through third-party channels, with the percentage even higher for the smaller banks.

Non-banks rely almost solely on adviser distribution.

But in a move welcomed by Financial Advice NZ, assessing compliance would not be done on a one-size-fits-all basis.

Instead, the guidance says financial institutions will be allowed to recognise the work on ethics that advisers have already done for themselves –requirements they will have already fulfilled by meeting the Code of Professional Conduct required by the FAP (Financial Advice Provider) regime.

“An intermediary that holds a FAP licence will pose a reduced level of risk that the institution’s distribution method will not meet the fair conduct principle,” the FMA guidance says.

Under the risk-based approach at the heart of the FMA guidance, this means that full-licence holders – effectively all advisers – could reasonably be assumed to have met high standards of conduct already.

Since it was required under FAP rules, oversight from a financial institution will have to take this into account or be “proportionate to the level of risk,” to quote the FMA document.

FCP to be a living document

Under CoFI, financial institutions are required to have a Fair Conduct Programme (FCP), which looks at not just policies of fair conduct but ways to make them work.

And an FCP should not be a one-time thing, but a living document which constantly reappraises ethical rules.

However, the FMA guidance document holds back from saying how often it should be reviewed, since the need to do so will vary from case to case.

And while an FCP must be communicated to intermediaries, the responsibility for working out systems to implement it would be shared between the institutions and intermediaries.

Once again, the administration of this system would be flexible.

“We consider that the requirement to take into account the types of intermediaries they use, and the legal obligations those intermediaries have, should help institutions have the confidence to comply with the CoFI distribution requirements in a manner that is proportionate to the level of risk associated with the type of intermediary,” the FMA states.

“Our view is that fair treatment is a shared responsibility of financial institutions and intermediaries.”

Formal agreement not essential

Another issue was how formalised the relationship between institutions and intermediaries should be.

“While we consider that contractual agreements are good practice, we acknowledge that there could be scenarios where it is not practical or proportionate to have one in place,” the FMA writes.

“In those cases, we expect financial institutions to be able to explain what processes and controls they have in place, in the absence of contractual provisions, to provide confidence that distribution involving those intermediaries will operate consistently with the fair conduct principle.

“If deficiencies in the arrangements with an intermediary are identified, the institution should consider what steps are needed to address these, which may include formalising the relationship.”

The guidelines go on to talk about the need for financial institutions to hold training courses for intermediaries.

But the principle of flexibility applies here too, since the extent of that training will be affected by an adviser's prior knowledge, such as having met and understood the standards of competence required under FAP protocols.

And the guidance further empowers advisers by saying that responsibility for the Code of Professional Conduct will apply to them, not to the financial institution which makes use of their talents.

Managing compliance costs

The guidance offered by the FMA acknowledges that there could be compliance measures which are onerous and costly for institutions and intermediaries.

But it thinks these can be managed.

“Our intention …. is to avoid unnecessary compliance costs. We want to reiterate that institutions can comply in a proportionate way, and this is consistent with our expectations.”

The FMA adds that it has heard of financial institutions responding to CoFI by imposing compliance measures in advance which go too far, and urges them to review these measures.

And it further spares advisers from the constant glare of financial institutions by listing things it does not want the institutions to do. These include:

• constant surveillance of intermediaries

• monitoring individual instances of advice or individual sales

• supervising intermediaries’ legal compliance on matters such as FAP

No audits required

The FMA’s new guidance also spares advisers another big cost: annual external audits or independent assurance reports.

It says the FMA was aware of institutions imposing this level of oversight on intermediaries, remarking that it could be costly - especially for intermediaries which distribute products and services of multiple financial institutions.

The guidance on this is emphatic: “CoFI does not impose any legislative requirement on institutions to require intermediaries to obtain annual external audits or independent assurance reports.”

Shanks says Financial Advice NZ was “very strong” in its submissions about the unintended consequences of CoFI.

One of her concerns was the widely forecast overlap between CoFI and the FSLAA.

“But I think this guidance has recognised that the two different legislative regimes, CoFI and FSLAA, will be able to work side by side instead of overlapping.

“We also like the emphasis on the risk-based approach towards distribution networks which carry a known risk [compared with those that don't].” ✚