FMC Act – An Overview

Introduction

The Financial Markets Conduct Act (“FMC Act”) was passed on 28 August 2013. This is a significant milestone for financial regulation in New Zealand.

The FMC Act rewrites many of the rules for how financial products and financial services are offered to the public and how they are governed and operated. It will replace the Securities Act 1978, the Securities Markets Act 1988, the Unit Trusts Act 1960, the Superannuation Schemes Act 1989, and the non-tax parts of the KiwiSaver Act 2006.

Key changes in the FMC Act include:

a. a new requirement for issuers to prepare a single product disclosure statement tailored to retail investors;
b. two new online public registers that are heralded as making offer documents and information much more accessible to investors, their advisers, market analysts, and commentators;
c. a new system of escalating penalties: from infringement notices (aka speeding tickets) for minor breaches through to penalties of up to $1 million for individuals, $5 million for companies and criminal penalties of up to 10 years’ prison for the worst conduct;
d. new licensing regimes for specific financial services providers including fund managers, independent trustees of workplace superannuation schemes, discretionary investment management services (DIMS) and derivatives issuers;
e. new forms of capital-raising, such as peer-to-peer lending and crowd-funding
f. new duties on fund managers and supervisors and stronger governance requirements; and
g. a new system to regulate securities exchanges such as NZX, including allowing for new low cost exchanges to make capital-raising easier and cheaper.

Purposes

In keeping with the drafting of modern legislation, by the Parliamentary Counsel Office, the FMA Act contains a description of the purposes of the Act, divided into:

a. Main purposes: Which are described as to:
• promote the confident and informed participation of businesses, investors, and consumers in the financial markets, and
• promote and facilitate the development of fair, efficient, and transparent financial markets.
b. Additional purposes: In addition the FMC Act is intended to:
• provide for timely, accurate and understandable information to be provided to persons to assist those persons to make decisions relating to financial products or the provision of financial services
• ensure that appropriate governance arrangements apply to financial products and certain financial services that allow for effective monitoring and reduce governance risks
• avoid unnecessary compliance costs, and
• promote innovation and flexibility in the financial markets.

Division into parts – functional division

In keeping with some of the predecessor legislation, the FMC Act is divided into parts by function, as follows:

Part 1:  Preliminary provisions, including:
• the purposes of the FMC Act;
• an overview of the Act; and
• interpretation matters.
Part 2:  Fair dealing in relation to financial products and financial services.
Part 3:  Disclosure of offers of financial products:
• disclosure to investors in relation to certain offers of financial products;
• advertisements for those offers; and
• ongoing disclosure to investors.
Part 4:  Governance of financial products, including:
• the governance of different categories of product;
• powers of intervention (by a supervisor or the FMA); and
• ongoing duties of issuers of all regulated products.
Part 5:  Dealing in financial products on markets, including matters previously dealt with the Securities Markets Act 1988.
Part 6:  Licensing and other regulation of market services, including the licensing of certain financial market service providers.
Part 7:  Financial Reporting obligations.
Part 8:  Enforcement, liability and appeals, including the imposition of civil liability and offences.
Part 9:  Regulations, transitional provisions and miscellaneous provisions, including powers to prescribe matters relating to the form and content of product disclosure statements.

A brief summary of the key elements of each functional division is set out below.

Part 1 – Preliminary provisions

Chief among the preliminary provisions are the definitions. In particular, the umbrella term “financial product” is defined to mean:

a. a debt security;
b. an equity security;
c. a managed investment product, or
d. a derivative,

with each of those terms being defined in a manner that focuses on the economic substance of the financial product rather than its legal form (e.g. a redeemable share is include within the definition of a debt security rather than equity ).

Also of note are the FMA’s ‘call in’ powers in Part 9, to:

a. declare that a security that would not otherwise be a financial product is a financial product of a particular kind; or
b. declare that a financial product is, or is to become, a financial product of a particular kind (whether or not it was previously a financial product of a different kind,

thereby providing the FMA with the power to deal with a security that might otherwise (as a matter of legal form) have escape the regulatory net, if necessary or desirable to promote the purposes of the FMC Act.

The call in powers can be used in a Blue Chip type structure to bring an investment product into the disclosure regime even if it is (deliberately) structured to fall outside – on the basis that the economic substance pointed to it being no different to regulated products (or regulated products of a particular category).

Part 2 – Fair dealing

The fair dealing provisions include:

a. prohibitions on misleading or deceptive conduct, false or misleading representations, and the making of unsubstantiated representations, in connection with financial products and financial services ; and
b. prohibitions on certain offers of financial products in the course of unsolicited meetings.

The fair dealing provisions are modelled on the Fair Trading Act 1986 and include some provisions also contained in the yet to be enacted Consumer Law Reform Bill.

Contraventions of the fair dealing provisions lead to exposure to civil liability with the FMA being the primary enforcement agency (with some scope for involvement of the Commerce Commission).

Part 3 – Disclosure of offers of financial products

The starting point for the disclosure regime under Part 3 is that offers of financial products for issue, and certain offers for sale, require disclosure using a product disclosure statement (“PDS”) unless the investor or the issuer is exempted under Schedule 1.

In a throwback to the soon to be extinct investment statement, the purpose of a PDS is stated to be that of providing certain information that is likely to assist a prudent but non-expert person to decide whether or not to acquire the financial products. In keeping with the Securities Act disclosure regime, the content of a PDS is largely to be prescribed by regulation – with different disclosure obligations being tailored to the category of financial product.

Significant, all “material information” relating to a regulated offer that is not contained in the PDS is to be contained in a register entry for the offer in an online register of offers of financial products. In Part 3, the term “material information” is defined, in relation to a regulated offer, to mean information that:

a. a reasonable person would expect to, or to be likely to, influence persons who commonly invest in financial products in deciding whether to acquire the financial products on offer; and
b. relates to the particular financial products on offer or the particular issuer, rather than to financial products generally or issuers generally.

However, “material information” does not include:

c. information about the specific terms of a financial product that have been customised for a particular investor; or
d. information about an identifiable investor.

Part 3 also contains detailed rules on offer advertisements, including what is seen as a welcome relaxation of the requirements governing pre-prospectus (pre-regulated offer) publicity.

To address another anomaly of the Securities Act disclosure regime, Part 3 contains a mechanism for ongoing disclosure by issuers, with a focus on issuers of debt and managed investment products, by providing:

a. a duty to notify the Registrar of relevant (prescribed) changes to keep the register details up to date – particularly relevant to continuous issuers and managed investment schemes;
b. a duty to disclose information to particular investors (on request or in prescribed circumstances), and
c. a duty to make information publicly known in prescribed circumstances.

These obligations have been described as taking the pressure off point of sale disclosure documents (and thereby curing some of the anomalies with the prospectus disclosure regime) – by enabling investors to be informed about their investment on an ongoing basis. This approach may also have the effect of enabling more accurate pricing of the investment product for the purposes of trading in the secondary market.

Part 4 – Governance of financial products

Part 4 provides for the governance of regulated products, including:

a. the governance of debt securities (including the need for a trust deed and a supervisor);
b. the governance of managed investment products (including the need for registration of the managed investment scheme, a governing document, and a supervisor);
c. the duties of persons associated with debt securities or registered schemes to make “protected” disclosures;
d. the powers of intervention to enable the supervision of debt securities and registered schemes by a supervisor or the FMA; and
e. ongoing duties of issuers of all regulated products (for example, to maintain registers of regulated products).

Part 5 – Dealing in financial products on markets

Part 5 provides for matters relating to dealing in financial products on markets, and carries forward (with some modifications) much of the Securities Markets Act, including:

a. prohibiting insider trading and market manipulation
b. providing for continuous disclosure by listed issuers
c. providing for the disclosure of interests of substantial product holders in listed issuers
d. providing for disclosure of relevant interests by directors and senior managers of listed issuers
e. providing for the licensing of markets for trading financial products
f. providing for the transfer of financial products, and
g. the making of regulations setting rules for unsolicited offers to purchase financial products.

Part 6 – Licensing and other regulation of market services

Part 6 regulates certain financial market services, including:

a. the licensing of certain financial market service providers (for example, managers of registered schemes, certain issuers of derivatives, and providers of intermediary services);
b. providing for disclosure obligations and the need for client agreements in connection with some of those financial market services;
c. imposing other conduct obligations on providers of discretionary investment management services and on their custodians, and
d. providing for the making of regulations regulating the holding and application of investor funds and property by issuers of derivatives.

Part 7 – Financial Reporting

Part 7 provides for financial reporting obligations, and the keeping of proper accounting records. It is likely that the enactment of the Financial Reporting Bill will result in further changes to include substantive obligations for issuers and managers of investment products in respect of financial reporting.

Part 8 – Enforcement, liability and appeals

Part 8 provides for enforcement and liability matters and for appeals, including:

a. providing the FMA and the High Court with certain powers to avoid, remedy, or mitigate any actual or likely adverse effects of contraventions of the FMC Act or the regulations made under the Act;
b. the imposition of civil remedies (including pecuniary penalty orders and compensation orders);
c. offences;
d. providing for appeals against the FMA’s decisions.

Whilst Part 8 provides the FMA with a range of powers to make orders, the focus of the FMC Act enforcement provisions is on civil remedies, including pecuniary penalties. Serious criminal offences are reserved for the most egregious conduct. An infringement notice (speeding ticket) regime is also provided as a more effective means of enforcing minor breaches.

Part 9 – Regulations, transitional provisions and miscellaneous provisions

Part 9 provides for:

a. regulations and exemptions, including powers to prescribe matters relating to the form and content of PDS’s;
b. powers for the FMA to designate financial products and offers, and to grant exemptions, where this is necessary or desirable in order to promote the main purposes of the FMC Act or any of the additional purposes of the FMC Act; and
c. various miscellaneous matters.

Schedule 1 – Exclusions and extension to certain sale offers

Schedule 1:

a. specifies that offers to particular persons do not require disclosure under Part 3 (although disclosure to other persons may be required):
b. specifies that certain offers as a whole do not require disclosure under Part 3, whether as a result of the nature of the offer (for example, a small offer) or the nature of the issuer (for example, an offer by the Crown);
c. provides for limited disclosure and other requirements, and for restrictions, in relation to the exclusions; and
d. extends the application of the disclosure regime to offers for sale of certain existing financial products.

The framework of the exclusions has been changed to include greater emphasis on ‘bright line’ tests. In addition, issuers will be able to rely on self-certification by wholesale investors that are exempt – unless they know, or ought to know, the certification is untrue.

Schedule 2 – Registers

Schedule 2:

a. establishes the register of offers of financial products
b. establishes the register of management investment schemes, and
c. contains procedural requirements for maintaining, searching, and lodgement of documents on the registers.

Schedule 3 – Self-managed superannuation schemes

Schedule 3 provides for the statutory recognition of single person self-managed superannuation schemes.

Schedule 4 – Transitional provisions

Schedule 4 contains detailed transitional provisions (in addition to the regulations that are to be made under Part 8 – which will specify transitional arrangements in further detail).

Commencement and transitional arrangements

The new regime under the FMC Act will commence progressively from April 2014 – under a transition period of 2 years. An exposure draft of the regulations is likely to be distribution for comment in October – and whilst there has been one round of consultation on the shape of the regulations – this is still quite a tight timetable for such a large body of new regulations.

The FMA has issued an indicative timeline which shows that the transition being implemented in phases:

Phase 1: From 1 April 2014:

• Part 2 “fair dealing” provisions will come into effect
• FMA will start to receive licence applications (although licences will not be required to be in place until later); and
• financial reporting requirements;
• some of the new exclusions in Schedule 1 will become available (e.g. employee share schemes, prescribed intermediaries such as crowd funding, and small offers) – on the basis that they will operate as exclusions from offers to the public under the Securities Act 1978; and
• conduct obligations for custodians (e.g. client reporting, assurance and audit etc.) in amendments to Financial Advisers Act (subject to further Cabinet decisions).

Phase 2: From 1 December 2014, the rest of the FMC Act will commence:

• the Part 3 disclosure rules;
• online register of offers of financial products and online register of managed investment schemes will become operational;
• the governance regime in Part 4;
• the remaining disclosure exclusions in Schedule 1 will become available
• the requirement to be licensed and all associated conduct requirements for licensees (with some transitional exclusions); and
• the liability regime will come into force, including that for defective financial product disclosure.

Some commentators have also noted that a number of market participants will no longer need authorisations to carry on their business. In addition, the FMA has signalled that some existing ‘participatory securities’ without an investment element are likely to fall outside the scope of the FMC Act .

Further information

If you would like more information about any of the matters discussed in this note, please contact me.