FMA consults on proposed new objectives for New Zealand’s financial markets.

In mid-November the Financial Markets Authority (FMA) published consultation documents that could potentially have far-reaching impacts and consequences for supervised financial markets entities and their licensed Supervisors. The consultation pertains to the proposed FMA guidance entitled Fair outcomes for consumers and markets (Guidance) with the subtitle “A guide to outcomes-focused regulation”. With the Guidance comes a set of Consultation questions (Questions). The 15-week consultation period opened on 15 November 2023, with a deadline for submissions of 1 March 2024. There is no room for complacency for those with an interest in making submissions, as the consultation period straddles the traditional summer extended holiday season and so in practical effect may be shorter than at first appearance.

In respect of the consultation, the FMA explicitly acknowledges that it is entering into new territory with its intended outcomes-focused regulation, albeit that it claims there is a precedent in its 2017 publication, A guide to the FMA’s view of conduct. In essence, the FMA is proposing to evolve its approach to compliance and enforcement into evaluating how successfully regulated financial product and service providers achieve each of seven “essential” prescribed “fair outcomes” for consumers and markets. Five of these fair outcomes are intended to benefit consumers whilst two are aimed at the functioning of markets. For consumers, the fair outcomes are:

1. Consumers have access to appropriate products and services that meet their needs,
2. Consumers receive useful information that aids good decisions,
3. Consumers receive fair value for money,
4. Consumers can trust providers to act in their interests, and
5. Consumers receive quality ongoing care.

For markets, the fair outcomes are:

1. Markets are trusted based on their integrity and transparency, and
2. Markets enable sustainable innovation and growth.

(Please see Appendix 1 for a tabulation of the seven fair outcomes and the FMA’s own reference documents pertaining to them as listed in the Guidance.)

There is some logical correspondence immediately apparent between the consumer fair outcomes and the market fair outcomes, for example between fair outcome four and fair outcome six. With others, the correspondences are not quite so clear unless the examples given in the Guidance as to how the fair outcomes are intended to cash out in practice are studied in detail. For example, it becomes evident that there is some linkage between fair outcome one and fair outcome seven by way of technological innovations.

Whether the seven fair outcomes are internally consistent and externally coherent with each other is not explicitly addressed in the Guidance, but it seems instead to be tacitly assumed that they are. What is clear, however, is that the Guidance reveals that the FMA intends to assess each financial product and service provider’s performance against all seven of the fair outcomes. It does not appear that there are any provisions for providers to opt out of adhering to any of the seven fair outcomes, for example, on the grounds that they are inapplicable or unsuitable. Whether the number of fair outcomes proposed is sufficient is left open in the consultation. In Questions it is asked at number 10, “Is there anything missing that should be included in the fair outcomes? Please explain.”

(Questions, p. 1)

Ethical imperative assumes supremacy

The notion of fairness – inextricably embedded in the concept of fair outcomes - is inherently ethical in origin and the FMA asserts that this notion is rooted in the key values of its role as a “kaitiaki of New Zealand’s financial markets” (Guidance p. 1). This role is described in the Guidance as determining the moral mission of the FMA:

“We work to foster the resilience of the whole financial sector by understanding and guiding conduct, connections, and interactions. This approach is underpinned by our determination to promote fair financial markets and financial wellbeing. Our actions are guided by doing what’s right, and our relationships are balanced by manaaki - acknowledging the mana of all others in all circumstances; and tiaki – nurturing pono, truth and authenticity.”

(Guidance, p. 4)

Infused with this mode of inspiration, the Guidance sets out what fair outcomes mean in practice:

“A fair outcome is the end result we are seeking for consumers and markets, and embeds the concept of pono (doing what is right). New Zealand’s financial markets conduct regime is designed to facilitate choice and flexibility for consumers and promote market innovation … it [means] products and services meet the needs of identified consumer groups and are targeted accordingly, and that providers ensure consumers have access to the knowledge and tools needed to make informed decisions and weigh consequences based on their individual preferences.”

(ibid, p. 5)

To implement its new outcomes-focused approach to regulation, the FMA will foreseeably need to become much more interventionist in New Zealand’s financial markets than before and potentially assume a greater burden of moral hazard that comes with such involvement. The Guidance proposes nothing less than seven standards of measurement whereby financial product and service providers will be judged on a pass/fail basis by the regulator, with potential time lags arising between when these providers have acted in a certain way and when there are any discernible related outcomes for consumers or markets that the regulator could pass judgement upon as to their fairness. Given that many financial products like KiwiSaver and insurance policies are credence products, meaning that their outcomes for consumers and markets are necessarily not known until some later and possibly quite distant date, the accountability for these outcomes could become quite problematic to predict, determine, and act upon.

The FMA states its position on outcomes-focused regulation in the Guidance as follows:

Outcomes-focused regulation is a regulatory approach that focuses on the end results we want to see “for consumers and markets. We need to be clear on the outcomes that matter, work together on this shared endeavour, and regulate in a way that gets us there.

This approach acknowledges that firms are better placed than regulators to determine what processes and actions are required within their businesses to achieve regulatory objectives. Instead of prescribing the processes or actions that firms must take, the FMA is setting out the outcomes that regulation seeks to achieve. We will then step back and let firms find the most efficient way to achieve these outcomes.”

(ibid, p.4)

However, this ostensibly hands-off approach once the goalposts have been set up may not be quite what market participants come to experience in practice. The Guidance goes on to state:

“Prioritising outcomes also means we will more easily be able to identify and challenge approaches that don’t support fairness. This will be an important part of our engagement model and the results we see in the market will alert us to where we need to have robust conversations about appropriate practices. Providers will all be working within the same outcomes-based framework, and those that want to do the right thing can have the confidence they won’t be at a competitive disadvantage. We will be outspoken where we see practices that are unfair and take enforcement action where appropriate.”

(ibid, p.4)

Fair outcomes and rules-based compliance

Outcomes-focused regulation is manifestly based on a means-ends conception, with the FMA defining the ends in its list of fair outcomes, but leaving it open to financial product and service providers each to find their own means to reach fair outcomes for which the regulator will hold them directly accountable and potentially legally liable. Fair outcomes are not the one and the same as the compliance of financial product and service providers with relevant laws and regulations overseen and enforced by the FMA. The Guidance compares fair outcomes with rule-governed compliance in a way that implies a moral hierarchy that places fair outcomes firmly at the top. Thus, for fair outcomes:

“These are not rules. They do not change firms’ obligations. They provide a focus for compliance and business efforts, supported by our existing legislative framework. Delivering these outcomes is the most effective way for good conduct to be demonstrated.”

(ibid, p. 3)

Whereas for legislative and regulatory compliance:

“While rules are still an integral part of regulation, we want to avoid a ‘tick box’ mentality where technical compliance is the end goal, as this may not provide the best result for consumers or markets. A focus on rules alone can create conditions where risks are either missed or over-managed and consumer harm goes unaddressed, and can also prevent swift behavioural changes (for example in response to new technologies and innovations).”

(ibid, p. 4)

The passage quoted immediately above is significant, as it states that technical compliance is not an end goal, which is consistent with the seven fair outcomes taking on that status, whilst the reference to new technologies and innovations implicitly points towards fair outcome number seven, “Markets enable sustainable innovation and growth.” Presumably if the FMA feels that a financial product or service provider is dragging the chain with respect to fair outcome number seven, then the provider concerned can expect to hear about that under outcomes-focused regulation.

How fair outcomes might operate in practice

As mentioned above, exactly what fair outcomes are supposed to mean in practice is elucidated by studying practical examples given under each one in the Guidance. Take fair outcome number one, “Consumers have access to appropriate products and services that meet their needs”. When looking under “Relevant issues and examples”, there are aspects of social engineering objectives apparent that presumably financial product and service providers are expected to comply with meeting. For example:

“FMA’s Consumer Experience with the Financial Sector Survey 2022 found that Māori communities were more likely to buy into riskier investments such as cryptocurrency, and may have lower trust in the banking sector. This indicates that more needs to be done to improve access to appropriate products and ensure our financial system is accommodating of a te ao Māori worldview to encourage participation.

Hard-to-reach consumers, such as those who live regionally or have lower levels of technological capability, may find themselves without access to financial products and services that are essential to daily life, like banking. Increasing digitisation can help improve access, but also risks excluding those who do not or cannot use certain forms of technology, so the use of multiple communication channels may assist.”

(ibid, p. 6)

The above examples apply to social minorities. The example given after them applies to a niche financial market, describing investors in complex financial products like derivatives as needing to be appropriately screened for their fitness to invest by their product providers. These various examples are implicitly referenced in fair outcome number seven, which states, “Innovation includes new market developments, often supported by technology adoption (including the use of AI), that create benefits for participants. For example, such benefits might include increased access to markets or screening out high-risk market participants”, (ibid, p. 12). Accordingly, under fair outcomes financial market product and service providers become gatekeepers charged with the ethical duty of letting people through into or shutting them out of financial markets, depending on which view of fair treatment is taken of such persons, and can expect to be judged by the FMA on their degree of success in this activity. With respect to the practical examples cited from fair outcome one, it would appear that the FMA would be holding to account providers who fail to reach out to the social minorities described and provide them with access to suitable products and services, including those that match investors’ subjective worldviews.

Major changes looming for supervised entities and their Supervisors

It is abundantly apparent from the Guidance that the FMA is expecting major ramifications to occur among financial product and service providers as they restructure themselves into entities that can meet the objectives and criteria laid down for them in the seven fair outcomes. Thus, it is stated in the Executive summary that, “Providers of financial products and services must take ownership of the outcomes and consider how their leadership, management, governance and operations all work together to deliver them in a way that is most appropriate and effective within their business context”, (ibid., p. 3). This imperative is echoed in the Guidance’s final page headed “What an outcomes-focused approach means”, wherein it is stated about providers that,

“Working towards fair outcomes will mean acting and thinking differently… For all, there will need to be a considered approach. While some practices, products and services will not change, it will not be enough to just continue with the status quo. All provider regardless of size, will need to understand how their governance, leadership, management and operations can deliver the fair outcomes, and where they need to make changes. They will need to keep their approach under review and adapt as circumstances change.”

(ibid, p. 13)

There are ramifications also for licensed Supervisors. If their supervised clients are expected to change and adapt to meet the demands of the seven fair outcomes, then Supervisors will also need to change and adapt in corresponding ways to ensure that they can continue to monitor and supervise their clients effectively. Whilst the Guidance promotes the idea that the seven fair outcomes will “help create certainty about the specific results [the FMA is] focused on”, (ibid, p. 5) and that the FMA is “developing a consistent approach and providing certainty about the results we are focused on”, (ibid; p. 5), potentially considerable uncertainty lies ahead for supervised entities and their supervisors as to how they will accommodate themselves to function appropriately within the brave new world of outcomes-focused regulation.

Accordingly, supervised entities, their supervisors, and the professional associations of each will need to do some deep thinking and prepare some well researched and appropriately validated submissions over the weeks ahead in order to meet the consultation’s deadline of 1 March 2024.

Conclusion

“The FMA’s consultation on introduction of outcomes-focused regulation is a must-read for boards and senior management of supervised entities,” said Matthew Band, General Manager of Trustees Corporate Supervision at Trustees Executors.

“The Guidance sets out very clearly that the FMA’s intended use of the proposed seven fair outcomes as external yardsticks for the performance of financial product and service providers is likely to trigger a cascade of changes right throughout their organisations from board level on down.”

“Providers need to be confident that they can comply with the new set of tests proposed for the fitness for purpose of the products and services that they bring to New Zealand’s consumers and markets.”

“The consultation period for submissions may seem a way off at 1 March 2023, but with the long holiday season in between then and now, providers should lose no time in putting their thinking caps on concerning submissions on the proposed Guidance.”

“Supervisors will also need to take both the Guidance and the consultation seriously as outcomes-focused regulation will potentially entail far-reaching implications for how they perform their duties and obligations.

“Some people might find themselves working through the holidays on preparing their organisations’ submissions.”

For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matt Band at [email protected].

Appendix 1: Seven fair outcomes and the FMA’s reference documents for them

*Reference documents not directly relevant to supervised entities have been omitted.