The Financial Markets Authority (FMA) has wrapped a surprisingly great idea in faulty packaging, according to a leading industry lawyer.
David Ireland, Kensington Swan partner, said the FMA plan, released in a new consultation paper last week, to split full financial advice licensing into three streams spoilt only by the naming conventions.
Under the FMA proposal, the regulator would issue three classes of advice licences, currently labeled A, B or C, according to business type. Broadly, the proposed Financial Advice Provider (FAP) designation defines:
- A-class as sole practitioners;
- B-class as FAPs that have, or intend to have, multiple financial advisers operating under the licence; and,
- C-class firms as those that can operate as all of the above in addition to employing ‘nominated representatives’ or providing advice via an ‘engaged entity’.
In effect, the ABC nomenclature maps adviser licensing onto the three main business models ranging from single-person firms to dealer groups to multi-disciplinary financial conglomerates.
“Many people might have been surprised by the three-class proposal but it’s a very clever idea that will enable the FMA to supervise the advice industry more efficiently,” Ireland said. “However, the regulator may have to change the ABC labeling as it could be confusing for consumers.”
He said the public usually conflates ‘A’ as a mark of higher quality while ‘C’ is just passable.
“That might seem a superficial point but history has shown that it’s really important to get the terminology right or consumers will get confused,” Ireland said.
Indeed, one aim of the Financial Services Legislation Amendment Act (FSLAA) was to tidy up the current jumble of advice acronyms that includes authorised financial advisers (AFAs), registered financial advisers (RFAs) and qualifying financial entities (QFEs).
In the run-up to FSLAA, there was much debate, too, about whether those employed to dispense product for financial firms should be called ‘agents’ – an argument settled with the ‘nominated representative’ designation.
“Rather than A, B and C, the licence name should just describe the business – say, single adviser, multiple adviser and complex – or something like that,” Ireland said.
He said other areas in the FMA proposal that should draw further comment include the standard licence conditions for record-keeping and professional indemnity (PI) insurance.
The consultation paper lays out eight ‘standard conditions’ for all full licence-holders under FSLAA.
Ireland said there was still “a lot of uncertainty” surrounding the full extent of record-keeping obligations, which could have important cost implications for financial advice firms.
As well, he said the requirement for all advice firms to have PI insurance was “problematic” in a market that can be difficult to source cover.
The FMA proposal does allow for PI exemptions where “an applicant demonstrates that they are unable to obtain appropriate cover, or has other valid reasons for not having cover, then we intend applying a specific licence condition waiving this standard condition”.
“The specific condition will require the disclosure to retail clients that the financial advice provider does not have professional indemnity cover,” the consultation paper says.
According to the FMA, PI cover is needed “to ensure that retail clients can be compensated for financial loss as a result of a breach of a professional duty by a financial advice provider and those they engage”.
Historically, however, PI insurance has not offered retail investors much protection against loss due to adviser indiscretions with most policies, for example, including fraud caveats.
Ireland said an alternative approach might be for the FMA to only require identified ‘high risk’ firms to have PI cover and to disclose the fact.
“That turns the FMA proposal on its head,” he said.
On the plus side, the regulator has clarified one point around FAP duties to vet external suppliers.
“Outsourcing of non-related services, such as office cleaning, are not covered by this condition,” the FMA paper says.
But while the eight proposed standard conditions are as expected, Ireland said there is at least one “surprise omission” from the regulator’s list.
“There’s no standard condition that FAPs have a ‘fair conduct’ obligation,” he said. “There is a fair treatment duty in FSLAA [and potentially in the imminent conduct of financial institution legislation] but I expected the FMA would want to leverage its power to look at fair conduct through licensing.”
Originally due to start this June, FSLAA transitional licensing has been delayed until at least next March following the coronavirus regulatory disruption. Advice businesses will have two years from the beginning of the transitional phase to earn a full FSLAA licence.
The FMA had received over 300 applications for transitional FAP licences ahead of the COVID-19 lockdown in March.
Final FAP numbers will probably breach the 2,000 mark with many solo advisers likely to apply for an A-class licence. As at last week, the Financial Services Providers Register listed 1,981 AFAs (up slightly compared to February) and almost 1,600 businesses that employ advisers, a rise of 200 over the last four months.
Submissions on the full licensing proposals are due in by close of business on August 7.
Ireland said the generous consultation period, which hasn’t always been a feature of the process, gives interested parties plenty of time to prepare feedback.
“This is a great opportunity for people to influence what the final rules will be,” he said. “The FMA will listen; it wants to get this right too.”
But Ireland said the FSLAA regime could face further delays unless the government releases the final disclosure regulations soon.
The Ministry of Business, Innovation and Employment (MBIE) tabled draft disclosure regs last October, closing submissions on the proposals in November. It is understood that feedback on the draft disclosure document was largely negative with a possible substantial rewrite on the cards.
“Many businesses may delay decisions about how they operate under FSLAA until the disclosure regulations are in place,” Ireland said.
The October proposals laid out a tiered disclosure process based on when certain advice thresholds were met.