Download: 2013 PUB BC DIMS and other devices - licence details becoming clearer - 17 July.pdf

The licensing regime for Discretionary Investment Management Services (DIMS) to be established by the Financial Markets Conduct Bill (FMCB) has come a long way since inception.

Regulation of DIMS under the Financial Advisers Act (FAA) has been aligned more closely to the FMCB via a Supplementary Order Paper (SOP) - in part to address the possibility of arbitrage between the two regimes. And the release last month of the licensing cabinet paper means that DIMS providers and other potential licensees now have a much clearer picture of the requirements that will be expected of them.

There is also an opportunity for input into the regulations under the FAA for DIMS, custodians and other brokers through a discussion paper put out yesterday by MBIE. Submissions close on Friday, 23 August 2013.

DIMS licence categories – FMCB or FAA?

The proposed boundary between who will be permitted to provide DIMS under the FAA and FMCB, discussed in our earlier commentary, has been further developed during the legislative process and in the SOP.

Service type Provide under FAA? Provide as DIMS licensee? Key changes in SOP
Non-personalised (class) DIMS provided to a retail clients (e.g. a portfolio programme offered to all-comers but not tailored to individual circumstances) No longer permitted Must be DIMS licensee A DIMS licence is compulsory for any type of class DIMS (prior to the SOP it was possible for an AFA, QFE adviser, registered individual, registered entity and exempt provider (except an overseas financial adviser) to provide class DIMS on category 2 products under the FAA).
Personalised DIMS provided to retail clients Yes – but can only be provided by AFAs and must be within scope of their authorisation. Yes Only AFAs can provide personalised DIMS to retail clients under the FAA. QFEs must be licensed under the FMCB (as must registered individuals who provide personalised retail DIMS on category 2 products).
DIMS provided to wholesale clients (i.e. not a "retail service" under FMCB) Yes – but if FMCB exemption applies then also exempt from FAA. Yes – but not compulsory as exemption applies Same as version of the Bill reported back from the Select Committee – no licence required if DIMS provided is not a retail service under FMCB (and also exempt from FAA).

Reducing regulatory arbitrage for DIMS providers

The risk of regulatory arbitrage between DIMS provided under the FAA and a DIMS licence under the FMCB has been reduced in the SOP by:

  • requiring that any provider of class DIMS to retail clients must be licensed under the FMCB (meaning that QFEs must be licensed under the FMCB for that service, rather than relying on any residual FAA ability)
  • providing that FMA may only authorise AFAs to provide personalised DIMS under the FAA if it is satisfied that the AFA meets prescribed requirements which match the FMCB, and requiring independent custody (already a feature of the FMCB)
  • clarifying that DIMS licensees will be acting as brokers under the FAA if they receive investor money.

These refinements provide a more logical outcome in terms of the "boundary" between the two pieces of legislation, as well as reducing the possibility of providers electing what they perceive to be a more "friendly" regime.

Helpfully, the SOP also makes it clearer that a DIMS which is not provided as a retail service will be exempt from the requirement for a licence (and fall outside the coverage of the FAA).

Licence conditions for DIMS licensees

The cabinet paper provides some helpful signals on what to expect in the regulations in relation to certain key areas for DIMS licensees.

  • Incidental advice – While advice on whether to join a DIMS will be financial advice covered by the FAA, any advice incidental to the operation of the DIMS (for example, changes to investment options) could give rise to similar regulatory issues. The solution is a sensible compromise – FMA will be able to impose licence conditions regulating incidental advice, rather than that incidental advice being automatically subject to the FAA.
  • DIMS client agreements – DIMS client agreements must provide adequately for custody and how rights relating to investor assets will be exercised. An investor will have the right to terminate a DIMS client agreement without penalty and take control of the assets within a reasonable period (the latter proposal is, again, sensible in our view as it recognises that an immediate liquidation of all client assets may be detrimental to the client's interest).
  • Record keeping – Records will need to be kept for at least seven years, covering all acquisitions and disposals of financial products during that time and the documents required to be produced by the licensee under the FMCB and regulations.
  • Wholesale DIMS – DIMs licensees who provide services to both retail and wholesale clients will need to inform wholesale clients that they are not subject to the same protections as the retail clients. Presumably, this will only apply to "hybrid" providers – as providers to solely wholesale investors will be exempt from the licensing requirements altogether.

Restricted scheme trustees

Trustees of restricted schemes (broadly industry, employer sponsored and other restricted offer superannuation and KiwiSaver schemes) are not required to have a licensed fund manager and supervisor. Instead, one of their trustees must be an independent trustee licensed by FMA.

Recognising that this model presents some risks in terms of trustee oversight (especially as trustees must generally act unanimously), the cabinet paper signals that there will be a whistle blowing obligation on independent trustees to report to FMA serious matters in relation to the scheme.

Administration managers, investment managers and auditors (and, for defined benefit schemes, actuaries) have had whistle blowing obligations for some years under the Superannuation Schemes Act 1989 and the KiwiSaver Act 2006, so this is not novel.

However, a key conceptual difference (which might make this a reasonably controversial regulation) is that requiring licensed independent trustees to report serious matters will effectively require them to tell on themselves.


The cabinet paper provides some useful indicators about the manner in which the derivatives issuers will be regulated.

  • Capital adequacy - FMA will continue to have a discretion, on a case by case basis, to impose capital adequacy and liquidity requirements on derivative issuers (although sensibly these requirements will not apply to entities which are already subject to prudential regulation by the Reserve Bank, including registered banks).
  • Client money - The basic approach to the handling of client money in the Futures Industry (Client Funds) Regulations 1990 will be continued (including keeping client money separate from the issuer's own funds). Also, the regulations will be designed to provide protection to clients when client money is used for hedging activities.
  • Reporting / record keeping - Standard licence conditions will govern ongoing client reporting by derivatives issuers to clients and record keeping. These are largely uncontroversial.
  • Product appropriateness - Interestingly, the cabinet paper indicates that FMA will continue to have discretion over product appropriateness requirements. While many issuers do currently consider appropriateness of derivatives products for their clients (a prudent course given recent Australian cases), giving FMA the flexibility to respond to activities of particular concern, without imposing general requirements, has some merit so long as there are sufficient guidelines for derivatives issuers to understand the circumstances justifying intervention. A similar approach is suggested in relation to leverage limits for clients.

General licensing criteria

The cabinet paper also gives some helpful signals in relation to the general principles to apply across all licensees, in terms of eligibility, criteria and licensing conditions.

  • Insurance requirements - FMA will be able to impose a condition that a licensee hold adequate insurance (as long as FMA is satisfied that it is necessary or desirable, having regard to the purposes of the FMCB).
  • Standard reporting - A standard licence condition will be that a licensee must report to FMA on certain prescribed matters such as insolvency and liquidation (but also more routine matters such as appointments of directors or senior managers and major transactions).
  • Outsourced functions - Interestingly, the cabinet paper signals that, in relation to outsourcing, the licence regime will be aligned with the governance requirements for managed investment schemes. In particular, terms will be implied in client agreements for retail services that the licensee must exercise care, diligence and skill, and will be liable for the performance of outsourced functions (including for a contractor's negligence).
  • Fit and proper persons - Unsurprisingly, directors and senior managers of licensees will be required to be "fit and proper" persons.

FMA to consult with Reserve Bank

FMA will be required to consult with the Reserve Bank when licensing banks, non-bank deposit takers and licensed insurers. We believe that the licensing regime could go further in this context and recognise that, for these entities with high levels of prudential supervision already in place, matters such as the fit and proper standards and insurance requirements should be deemed to be satisfied, rather than being subject to a residual consultation obligation.

Other licensed categories

The cabinet paper also signals that person to person lending services and equity based crowd funding services will be brought within the licensing regime, through regulations. This will be a welcome development for many participants in the start-up and venture capital sectors, where these types of funding sources are an attractive alternative to retail offerings which inevitably will carry higher compliance costs. These two types of licence will be dealt with in a separate brief counsel.

Next steps

Financial institutions gearing up for multiple licence categories may still be able to influence the finer workings of the licensing regime – both through the MBIE discussion paper and through the exposure draft of the regulations due to be released later this year.

The evidence from the response so far, as demonstrated in the SOP and in the cabinet papers, is that engagement in the process can be beneficial.

Chapman Tripp's earlier commentaries on the Bill are available here.

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.