New Zealand: Financial Markets Conduct Bill - Part 4 – Governance of financial products

Last Updated: 29 April 2012

Extent to which superannuation scheme may provide non-retirement benefits
40 Section 116 prescribes that the requirements in section 115(1)(b) and (d) that a superannuation scheme:

40.1 must have the purpose of providing retirement benefits, and

40.2 must ensure that redemptions or withdrawals are for retirement purposes

do not prevent a scheme from providing insurance benefits or allowing withdrawals in defined circumstances such as financial hardship, ceasing employment or changing employment (or in accordance with other limited early partial withdrawal criteria defined in trust deeds).

41 Those other benefits or withdrawal facilities must be "merely ancillary" to the purpose of providing retirement benefits. This concept is given a narrow meaning adapted from the ancillary non-charitable purpose concept in section 5(4) of the Charities Act 2005.

42 Section 116 is potentially much more restrictive than the current "principal purpose" requirement in section 2A(1)(a)(i) of the Superannuation Schemes Act 1989.

43 Superannuation schemes feature a wide range of benefit designs. For example:

43.1 proportionately few of the benefits paid from an employment-related scheme will ever be paid as the true retirement benefits, instead most will be paid when members change employers

43.2 not all death or disablement benefits will have an insured component, and

43.3 retail schemes commonly allow full withdrawals from a prescribed age such as 55 without requiring proof of (or drawing a connection to) retirement.

44 Section 116 will therefore likely present compliance difficulties for a number of existing superannuation schemes. We submit that existing early withdrawal facilities in already-registered superannuation schemes should be grandfathered, given that all will already have had to meet the principal purpose test prescribed in the Superannuation Schemes Act 1989).

Governing document should only specify method for calculating price, not minimum price
45 Section 122(1)(a)(ii) requires a registered scheme?s governing document to prescribe the method of calculating the "minimum" price at which interests are to be redeemed.

46 We submit that the reference to "minimum" price is unnecessary, and that a simple reference to the "price" at which interests are to be redeemed is sufficient. In most cases, governing documents do not refer to a "minimum" price. They simply refer to a "redemption" price.

47 Requiring the contents of governing documents to specify the method of calculating a minimum price is unduly restrictive, and could restrict some issuers from specifying differential pricing where circumstances require it (which, while unusual, is not unheard of).

Governing document should only specify extent to which prescribed persons may be indemnified
48 Section 122(1)(f) requires a registered scheme?s governing document to provide adequately for any rights of a manager, investment manager, administration manager, supervisor or custodian to be indemnified out of scheme property.

49 Investment managers, administration managers and custodians will typically not be parties to the governing document and will be engaged under separate contracts for services. Subject to legislation, whether (and, if so, to what extent) they are indemnified from scheme assets will be a matter for commercial negotiation.

50 We submit that section 122(1)(f) should end with the words:

", and the extent to which any of those persons may be indemnified out of scheme property."

Limits on permitted exonerations and indemnities 51 The "proper performance" concept in section 123(2)(b) should be widened so as not to prohibit exoneration or indemnity protection for purely technical breaches, such as:

51.1 a SIPO breach (see section 130(1)(b)) occurring due to market movements despite proper management of trades, or

51.2 deviations outside permitted investment ranges which are restored within an appropriate period of time.

52 The exclusions also should not apply to overseas investment managers. Many overseas investment managers cannot deviate from their standard terms due to governance policies, and New Zealand investors should not be denied the opportunity to have those investment managers available to them.

53 In addition:

53.1 in assessing whether performance has been "proper", regard must be had to the characteristics of the scheme and the actions of investors – for example, there should be no suggestion that a manager has been imprudent for lack of spread of investments if the investment mandate of the scheme is limited or if a particular course of action has been approved by a special resolution of participants, and

53.2 the clause should not apply to existing schemes which already have indemnities embedded in their governing documents. These clauses were negotiated long ago taking into account the risks inherent at the time, and asking participants to revisit them is, in our view, overly intrusive.

Changes to governing document
54 For a superannuation or KiwiSaver scheme, section 126(3)(b) will be significantly more restrictive than the current legislation in that, as matters stand, benefits referable to future (as opposed to past) membership periods can be reduced without any prior member consents.

55 Employers sponsoring superannuation schemes should retain the flexibility to amend trust deeds or participation arrangements so as to (for example) reduce their future contributions:

55.1 in order to apply a progressively greater KiwiSaver contributions offset, as CEC rates increase over time, and/or

55.2 in order to put in place a revised remuneration structure which provides salary increases or other additional benefits to compensate employee members for a diminution in their future service superannuation entitlements.

56 We submit that amendment powers in existing trust deeds – for all types of managed investment schemes - should be permitted to be preserved with respect to existing subscribers, who subscribed based on that greater flexibility.

57 Changes should also be expressly permitted in order to address law changes or to prescribe amendments that are technical or administrative in nature.

Power to make FMA–approved changes
58 We submit that for certainty and flexibility, and for consistency with section 692, section 127(1)(a) should allow an FMA-approved amendment that is "necessary or desirable to enable, or in connection with enabling the governing document to comply" with the relevant sections or any enactment or rule of law.

Contracting out of management functions
59 It is common for trust deeds for managed investment schemes to provide that, where functions are contracted out (for example, custody, registry or investment management), the fund manager is not liable for performance by the contractee, as long as the contracting out is reasonable and has been appropriately monitored.

60 Section 133(2)(b) is inconsistent with this practice. It provides that the manager would continue to be liable for the contractee?s performance in a contracting out situation.

61 We submit that this provision should be amended so that a manager who has complied with sections 131 and 133(2)(a) in connection with the contracting out is not liable for the fault of contractees – so that this type of limitation is properly able to be included in trust deeds and governing documents, rather than being overridden by section 133(2)(b).

62 The scheme will have a contractual claim against the third party provider in cases of breach, which the manager must pursue in accordance with section 130.

Statement of Investment Policy and Objectives
63 Section 150(1)(c) of the Bill requires a Statement of Investment Policy and Objectives (SIPO) to include the methodology used for "measuring performance against... investment strategy".

64 Performance is generally not measured against the "investment strategy". Rather, the investment strategy is merely a contributor to a "performance objective" or "benchmark".

65 The terminology in this clause should therefore be changed so that the SIPO is required to include a description of how the scheme measures performance against a performance objective or benchmark, not the investment strategy.

Related party benefits

Fees payable to other parties should not be related party benefits
66 Section 158(1)(c) provides that fees or expenses payable or reimbursed to a manager of a registered scheme are not "related party benefits".

67 We submit that fees or expenses paid or reimbursed to any investment manager or administration manager should likewise not be related party benefits. It is not uncommon for these entities to be related to the manager, and we see no policy reason to distinguish them in this context.

General prohibition on related party benefits
68 In section 159(3)(a)(ii) and elsewhere in the Bill, references to approval by special resolution of the class of affected scheme participants should be supplemented (as alternatives) by references to approval arising from:

68.1 transactions of the relevant type being permitted in the governing document and PDS, and

68.2 investors subscribing on that basis.

General notifications should be possible
69 Sections 160(b) and (c) recognise that investments in other managed investment schemes or in category 2 products issued by a registered bank (or products prescribed which are issued by subsidiaries of registered banks) do not require supervisor consent as related party transactions. However, under section 159(2), the manager must still notify the supervisor of the transaction.

70 It is not uncommon for managed investment schemes to make initial and follow-on investments in other managed investment schemes (or category 2 products issued by banks or their subsidiaries). A good example is a bank cash PIE, where its sole investment is to invest in bank issued cash deposits.

71 We submit that section 159(2) should be amended to allow a notification to be given either generally or specifically in the context of a particular transaction. Without this amendment, multiple notifications in relation to repeated identical related party transactions would be required for related party investments by continuously offered registered schemes. This would be highly impracticable.

Additional restrictions on related party transactions of restricted schemes
72 We submit that in section 161 the prescribed 5% limit must be expressed in benchmark (not actual) asset allocation terms so that, for example, there are no accidental limit breaks triggered by related party investments? outperformance from time to time.

73 We also submit that it is inappropriately restrictive to treat as a "related party" every employer contributor to a restricted scheme which:

73.1 has restricted status under definable community of interest criteria, and

73.2 is therefore more widely offered than a single-employer or single-group scheme, including through various employers with no shared ownership or association either legally or in a business sense.

74 Certain superannuation and KiwiSaver schemes (such as faith-based schemes) with restricted status under the definable community of interest criterion will have numerous unrelated employer contributor; including, in some cases, stock exchangelisted companies. As section 158(2)(a)(iii) stands, all will be "related parties of the scheme" if they employ as few as one or two contributors to the scheme. We therefore submit that the "related party of the scheme" definition should exclude any employer which:

74.1 is not a party to the trust deed, and

74.2 has no role in relation to trusteeship or scheme management, and

74.3 is not an associated person of any party to the trust deed (or of any person or entity which has a role in relation to scheme trusteeship or management)

meaning that an employer whose only real connection to a scheme is (for example) making compulsory employer contributions under the KiwiSaver Act 2006 with respect to certain employees is not treated as a related party of that scheme.

75 We also submit that the 5% restriction should be refined so as to make clear that it applies only to investments in any particular related party of the scheme (and associated persons of that related party). This would mean that (for example) investments in businesses which:

75.1 were each a "related party of the scheme" as defined, but

75.2 were not associated persons of each other

would be counted separately for the purpose of testing compliance with the 5% constraint – i.e. such investments would be permitted so long as no one investment exceeded 5% of scheme assets.

76 The basis for this submission is that (in terms of the Explanatory Note to the Bill) the express policy underlying the 5% restriction was as follows:

"The intent of this limitation is to ensure that if an employee?s employer fails and they lose their job, there is a reduced likelihood of the employee also losing a significant portion of the value of their superannuation scheme."

77 In practical terms that concern simply does not arise where a scheme?s total exposure to any one employer (or to any one group of associated employers) is less than 5%, with all other assets more widely held.

Power of supervisor to remove manager
78 Section 169(1)(a) allows the supervisor to remove the manager if the supervisor considers that removal is in "the best interests of scheme participants".

79 Without some form of qualification, there is a concern that supervisors will need to periodically "test the market" to assess whether the manager is currently the optimal choice for participants, or whether there may be an alternative (and cheaper) manager available. It could also incentivise would-be managers to attempt to seize control of management rights by offering short term incentives (e.g. lower fees) to attempt to unseat the incumbent.

80 In our view, it should not be the intention (or effect) of this clause to require the supervisor to monitor the market, or encourage short-term anti-manager activism. Accordingly, we submit that there should be a requirement that clear evidence is required before this power can be used (i.e. effectively a presumption in favour of the current manager).

Power of supervisor or FMA to apply for order to remedy problem
81 Section 191(1)(d) allows a supervisor or the FMA to apply for orders if the financial position of a scheme is "otherwise inadequate".

82 We submit that, in order to provide more certainty in regard to whether a particular position is "otherwise inadequate", this standard should be determined by reference to frameworks or methodologies specified by the FMA under Subpart 4 at Part 8.

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The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

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