Improving market governance of the New Zealand Emissions Trading Scheme

Option one: Existing legislation (status quo)

Under the status quo, advice relating to NZUs is partially covered by four Acts: the Fair Trading Act 1986, the Forests Act 1949, the FMC Act and the Financial Service Providers (Registration and Dispute Resolution) Act 2008.

The status quo also captures private remedies that exist independently of statute, such as a claim for breach of contract.

Coverage under the FTA

For trade in general goods and services, the FTA seeks to protect consumer interests and to allow businesses and consumers to participate confidently in trade. The FTA does this by prohibiting certain unfair conduct and practices, and providing for proportionate offences, penalties and avenues for consumer redress.

NZU advice remains within the general remit of the FTA as a service (unless parties lawfully contract out).

Consumer protections are limited, and the key avenue for remedy is to take a claim to the Disputes Tribunal, the District Court or the High Court. The jurisdiction of the Disputes Tribunal is limited to making orders for values and amounts that do not exceed $30,000; the District Court’s jurisdictional limit for such orders is $350,000; the High Court has unlimited jurisdiction.

As for all services governed by the FTA, the Commerce Commission can:

• receive and investigate complaints
• provide advice and/or warnings
• take enforcement action.

As above, the penalties and offences are designed for general services and are lower than the approaches and maximums set out in the FMC Act for financial products and financial services.

Coverage under the Forests Act 1949

In the case where two parties in the forestry sector contract out of the FTA, there may remain protections under the Forests Act 1949.

In that case, under section 63V(2) of the Forests Act 1949 [New Zealand Legislation website], any person may complain to the Forestry Authority (or the Forestry Authority may itself initiate a complaint) that a person has engaged in unsatisfactory conduct or misconduct in their capacity as a registered person.

If the Forestry Authority is satisfied that a person has, in their capacity as a registered person, engaged in misconduct (as defined in section 63ZI [New Zealand Legislation website]), the Forestry Authority may consider whether there are grounds to prosecute the person for an offence under section 63ZK [New Zealand Legislation website]. A person who commits an offence under section 63ZK is liable on conviction for a fine (not exceeding $40,000 in the case of an individual, and $100,000 in any other case).

Coverage under the FMC Act and Financial Service Providers (Registration and Dispute Resolution) Act 2008

Ancillary services (such as the managing or administering of money) provided in connection with NZ ETS-related transactions by persons that are in the business of providing a ‘financial service’* are governed by the FMC Act fair-dealing provisions.

There are stronger consumer protections for this component of services, including:

• fair dealing rules that are tailored to dealings in financial products and financial services
• providers are required to register on the Financial Service Providers Register (FSPR).
• providing services to retail clients requires mandatory membership of an approved dispute-resolution scheme.

The FMA has regulatory remit over financial service providers and has access to a broader range of regulatory tools when considering intervening. As well as providing guidance and undertaking investigations, the FMA may issue stop orders to pause or end conduct. These orders can be used to stop or prevent advertising or disclosure that confuses, or is likely to confuse, consumers or investors on matters that influence their investment decisions. For example, the FMA could issue a stop order to restrict the supply, or possible supply, of services that are likely to mislead or confuse in a serious manner.

The FMA may also take prosecutions for breaches of the fair-dealing provisions. As noted above, the offences and penalties are tailored to financial products and financial services, where there is a much greater prospect of financial harm or loss than other types of services.

Option two: Regulating NZU financial advice, transactional and/or custodial services

Under option two, we would extend the regulation of financial advice to persons who, as part of their ordinary course of business, make recommendations or give an opinion about acquiring, disposing of, or holding NZUs.

Duties and licensing requirements for NZU advisers

All duties and licensing requirements are discussed further in the ‘What this proposal means in practice’ section below. At a high level, obligations include the following:

• Licensing: Under the financial advice regime, anyone who gives regulated financial advice to retail clients must hold or operate under a licence granted by the FMA.
• Registration: All financial service providers are required to register on the FSPR (under the Financial Service Providers (Registration and Dispute Resolution) Act 2008).
• Fair dealing: As is applied under the FMC Act, fair dealing includes:
  • not engaging in misleading or deceptive conduct
  • not making false or misleading representations
  • not making unsubstantiated representations.

Fair-dealing requirements for NZU advisers would ensure that ‘NZU financial advice’ is treated on a like-for-like basis with ‘financial advice’, in order to enhance the integrity and confidence of the NZU market.

• Statutory duties: In providing financial advice, all financial advice providers must:
  • exercise care, diligence and skill
  • give priority to client’s interests where the provider knows, or ought to reasonably know, there is a conflict between the provider’s and the client’s interests
  • comply with a code of conduct and other statutory duties if they give regulated financial advice to retail clients.

Table 10 below indicates, at a high level, what changes this proposal is intended to make to the current regulatory environment.

Fair dealing

This proposal adopts the same requirements as the fair-dealing standards under the FMC Act in relation to financial services, including:

• not engaging in misleading or deceptive conduct
• not making false or misleading representations
• not making unsubstantiated representations.

These obligations are broadly the same as the FTA fair-dealing provisions. However, applying the same concepts as the FMC Act means that the FMA can take enforcement action, and higher maximum penalties would apply. It ensures that ‘NZU financial advice’ is treated on a like-for-like basis with ‘financial advice’, to enhance the integrity and confidence of the NZU market in a fair and transparent manner.

Licensing

Under the financial advice regime, anyone who gives regulated financial advice to retail clients must hold or operate under a licence granted by the FMA.

However, providers are exempt from the licensing requirement in respect of a service that is not provided to any retail clients (ie, provided to wholesale clients only), although they may opt for voluntary licensing.

The distinction between retail and wholesale clients also affects the duties that financial advice providers must comply with to give financial advice, and whether or not belonging to a dispute-resolution scheme is mandatory. These definitions are expanded further below.

Licensing can be at the firm level – that is, if a firm employs individuals to give advice on its behalf, then it is the firm that needs to be licensed by the FMA. The firm must take all reasonable steps to ensure its advisers comply with obligations.

Before granting a licence, the FMA must be satisfied about various matters, including that:

• directors and senior managers are fit and proper persons
• the applicant is capable of effectively performing the service
• there is no reason to believe that the applicant is likely to breach its obligations.

Similar requirements for licensing NZU advice businesses would:

• give clients confidence that licensed firms have been through checks conducted by the FMA
• give the FMA further information to assist its monitoring of NZU advisers
• add financial and non-financial compliance costs due to FMA levies, as licence application fees vary based on the class of licence.* Applicants also need to spend time and resources to put in place the policies and processes necessary to meet the licensing standard.

The FMA sets out its expectations around licensing requirements in its Guide to Financial Advice Provider [PDF, 1,237 KB] licence requirements and application kit.

Financial advice licences also have standard conditions relating to: record-keeping, internal complaints processes, regulatory returns, outsourcing, business continuity and technology systems, ongoing requirements and notification of material changes.**

Duties in providing financial advice

All advice providers

All providers of financial advice must comply with minimum statutory duties that include:

• exercising care, diligence and skill that a prudent person engaged in the occupation of giving regulated financial advice would exercise in the same circumstances
• giving priority to a client’s interests where the provider knows, or ought to reasonably know, there is a conflict between the provider’s and the client’s interests.

Advice to retail clients

Providers who give regulated financial advice to a retail client must comply with additional statutory duties, including:

• complying with the standards of ethical behaviour, conduct and client care required by the Code of Professional Conduct for Financial Advice Services [Financial Advice Code website]
• meeting the standards provided in the code of competence, knowledge and skill in giving advice, and meeting any prescribed eligibility criteria to give advice
• taking reasonable steps to ensure the client understands the nature and scope of the advice being given, including any limitations on the nature and scope of the advice
• making prescribed disclosure information available, including
  • making certain information publicly available (to help the public with choosing an adviser)
  • disclosing certain information to the client (to help potential clients decide whether to obtain advice from that adviser, and to help clients decide whether to follow the advice given)
  • providing, at prescribed times (such as when the provider knows the nature and scope of the advice service the client is seeking), information about the firm’s licence, the scope of advice, fees, commissions, conflicts, disciplinary history, and conduct obligations and complaints process.

The Code of Professional Conduct for Financial Advice Services contains nine standards and, among other matters, sets out the following:

• The standard of general competence, knowledge and skill means that the person has capabilities equivalent to the New Zealand Certificate in Financial Services (Level 5), version 2.***
• Individuals are required, at least annually, to plan for and progressively complete learning activities designed to ensure they maintain the competence, knowledge and skill for the financial advice they give, as well as an up-to-date understanding of the regulatory framework for financial advice in Aotearoa New Zealand.

It is proposed that these obligations also apply to persons that provide NZU financial advice.

Registration and dispute resolution

All financial service providers are required to register on the FSPR**** under the Financial Service Providers (Registration and Dispute Resolution) Act 2008.

In practice, the following would apply under the NZU financial advice proposal:

• For advice to retail clients, both the financial advice provider and individual advisers***** would be required to register on the FSPR. Registration and annual confirmation fees would be payable.******
• Where a provider gives advice only to wholesale clients, only the provider/firm needs to register.

Registration enables government agencies and the public to know who is providing financial advice services and includes criminal history checks on the applicant and its directors/senior managers/controlling owners.

Where financial services are provided to a retail client, the provider must belong to an approved dispute-resolution scheme. This requirement does not apply to financial services provided to a wholesale client.

If a provider gives poor or misleading advice, the retail client can bring a complaint to the provider’s internal complaints-handling process. If the internal complaints-handling process does not resolve the complaint, it can be forwarded to the provider’s dispute-resolution scheme at no cost to the client.

The scheme can consider breach of contract, industry codes and legal obligations. Depending on the severity of the complaint, the findings of the scheme can result in a range of orders, including compensation.******* Providers are required to pay an annual fee to belong to a scheme and an investigation fee per complaint (the fee varies by scheme).

Meaning of wholesale and retail clients

The regulation that applies to services provided to retail clients is significantly higher than for wholesale clients. This is because wholesale clients are generally considered to have greater experience in investing, financial expertise and wealth. Typically they are also better placed than retail investors to assess risks and seek additional information (including financial advice) where required, and therefore need less protection.

The meaning of ‘wholesale client’ is set out under clauses 37–41 of Schedule 1 of the FMC Act [New Zealand Legislation website] as a person (including entities controlled by the person and, as relevant, on a consolidated basis) who meets any one of the following summarised criteria:

• Investment business: A person who is, for example, a principal business investing in financial products, a registered bank, a financial adviser or issuer of derivatives.
• Investment activity criteria: A person who has, within the previous two years, owned a portfolio of (or carried out one or more transactions to acquire) specified financial products******** of a value of (or where the amount payable under those transactions was) at least $1 million (in aggregate).
• A large person: A person who (including entities controlled by the person and, as relevant, on a consolidated basis) had net assets in excess of $5 million as at the last day of each of the two most recently completed financial years.

It may be simpler for our proposal to adopt the same wholesale/retail distinction above for NZU financial advice. Using different wholesale/retail thresholds could introduce complexity, particularly if it leads to the same person being a retail client for one purpose (getting NZU financial advice) but a wholesale client for another purpose (getting financial advice about NZU derivatives or about any other financial product).

If adopting the same definitions (eg, if NZUs were a specified financial product for the purpose of the investment activity criteria described above, and thresholds were otherwise unchanged), that means a person who held more than $1 million of NZUs at any point in the past two years would be treated as a wholesale client.

We are conscious this could mean a number of small forestry participants would not benefit from the full protections of this proposal. We also note that the FMC Act thresholds were developed in the context of parties who buy or hold investment financial products generally by choice, whereas in NZU markets some parties need to hold NZUs to meet surrender obligations.

We seek feedback on whether the existing FMC Act distinction is appropriate in the context of NZUs.

Professional training and qualifications about the NZ ETS

There is a current gap between those who provide NZU advice and their qualification credentials. For example:

• forestry advisers do not explicitly have NZ ETS, NZU market or financial training in their qualifications
• financial adviser qualifications do not entail NZ ETS or NZU market training
• there is a general lack of formal NZ ETS or NZU market training across NZ ETS information providers.

A standardised qualification providing targeted professional modules would bridge the gap between the advice currently given to clients on how to manage NZUs and its financial implications.

Fees and levies

The FMA is funded through a combination of levies charged to financial markets participants, Crown funding, and licensing fees.

The FMA has a cost-recovery model for the licensing and regulatory oversight of the financial advice sector. Under this proposal, no change is intended to the way FMA currently collects fees and levies for this sector.

The size of any levies for NZU financial advice providers would be considered later. If NZU advisers and financial advisers are subject to similar levels of regulation by the FMA, it may be appropriate that NZU advisers pay similar FMA levies.*********

For these financial advice providers that require a licence, the minimum application fees are:

• Class 1 licence (sole-advisers): $703.80 (includes up to two hours’ assessment time)
• Class 2 licence (businesses that engage more than one adviser): $882.05 (includes up to three hours’ assessment time)
• Class 3 licence (large organisations with nominated representatives): $1,060.30 (includes up to four hours’ assessment time).

Additional fees may apply, at a rate of $178.35 per hour, if the application assessment exceeds the allocated hours.

We have received complaints of NZETR account operators withholding access to NZUs from account holders. We want to understand the gravity of this risk in the NZU market and possible solutions to mitigate this risk.

Persons who receive client money, or client money in connection with a financial advice product, are subject to the client money or property service regime under the FMC Act. This regime is not part of financial advice regulation. It imposes key duties and obligations to help ensure providers meet minimum conduct, disclosure and record-keeping standards (among other things).

However, there are material differences between the holding of client money and client NZUs, compared with other financial products under the FMA regime, which require further thought. These differences are:

• how ownership of NZUs is recorded, managed and administered compared to other financial product markets
• the role of account operators in the NZETR.

While client money or property services for NZUs were not proposed in the previous 2021 market governance consultation, the purpose of looking at it in this topic is to consider consistent treatment between persons providing client money or property services in relation to financial advice products (eg, shares) and persons providing equivalent services in the NZU market.

As part of this discussion document, we seek views on what role (if any) a client money and property regime should play in the NZU market.

What is a client money or property service?

At a high level, a person provides a client money or property service by:

• receiving money from a client (or from a person on the client’s behalf) in connection with the acquiring, holding or disposing of a financial advice product
• receiving property from a client (or from a person on the client’s behalf) that is a financial advice product, a beneficial interest in a financial advice product, or in connection with a financial advice product
• holding, paying, or transferring that client money or client property.

It includes a custodial service, whereby a person holds the client money or client property on trust for, or on behalf of, a client (or another person nominated by the client).

Broadly speaking, under financial markets legislation, a custodian is a provider who holds money or property for clients, rather than someone who merely executes orders to pay or transfer money or property to another person. Providing a custodial service is when a person:

• holds client money or client property on trust for a client (Person A) or another person nominated by Person A (Person B) under an arrangement between Person A and Person B
• holds client money or client property on trust for another person with whom Person A has an arrangement.

In practical terms, if NZUs were to be included within the definition of a financial advice product, then client money or property services could include:

• receiving money or property in connection with the acquisition or disposition of a client’s NZUs (eg, the purchase, sale or transfer of NZUs), and holding, paying, or transferring that money or property
• receiving payment from a client to acquire NZUs on their behalf
• holding and/or administering a portfolio of a client’s NZUs (where, for example, a firm holds legal title to the NZUs on trust for the client who owns the beneficial interest).

A service is a regulated client money or property service if it is not excluded under Part 3 of Schedule 5 of the FMC Act [New Zealand Legislation website] (which relate to, for example, the Crown or ancillary services such as conveyancing).

What regulatory obligations would apply to a client money or property service?

Client money or property service providers do not require a licence to operate. They must, however, comply with a set of statutory obligations and register on the FSPR.

Conduct obligations

All providers of regulated client money or property services must:

• exercise the care, diligence, and skill that a prudent person engaged in the business of providing the service would exercise in the same circumstances
• not receive client money or client property for the acquisition of a financial product if the provider knows, or ought to reasonably know, the product was made under an offer that contravenes the FMC Act.

Providers of regulated client money or property services to retail clients (as defined above) have additional duties to:

• make prescribed disclosures to the retail client before receiving client money or property (or, if not practicable, as soon as practicable after receiving the same)
• not make false or misleading statements or omissions in the prescribed disclosures.

There are currently no prescribed disclosures.

Handling obligations

Some providers (such as those who provide these services to a retail client) must also comply with obligations for handling client money and client property, including:

• paying client money into a separate trust account in Aotearoa New Zealand and ensuring the money or property is held on trust for the client
• account properly (or ensure the account is properly made) to the client for that client money
• keeping, or ensuring there are kept, trust account records that clearly disclose the position of the client money in the trust account (and/or the equivalent records for client property)
• must not use client money or client property for any other purpose than as expressly directed by the client.

Custodians

Custodians also have obligations to:

• report to clients about their money and property held
• reconcile records
• obtain and submit to the FMA an annual assurance report from an auditor qualified to carry out audits under the FMC Act in relation to the custodian’s processes, procedures and controls.*

Registration costs

All registered financial service providers must pay registration and annual fees and levies. Table 13 summarises the fees and levies for financial service providers. Table 14 details the fees and levies for custodians and client money or property services. Additional administrative costs can be incurred in the form of time spent to meet obligations.

Table 13: Registration fees and levies for financial service providers

Table 14: Annual FMA levies for custodians and client money or property services