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STAFF PAPER ON REGULATING AND SUPERVISING FINANCIAL ADVISERS

Who might apply to be a QFE?

69. Just because a firm has employees or agents who are financial advisers does not mean that it will necessarily make sense for it to be a QFE.
70. Large financial institutions are clearly within the intended scope of the QFE regime. Smaller firms may be considering applying for QFE status too. Firms outside the finance sector may also be contemplating whether to apply for QFE status - the impact of the Financial Advisers Act extends beyond the finance sector to, for example, retailers and motor vehicle dealers in relation to consumer finance arrangements, and travel agents in relation to travel insurance. It may be relevant for those involved in point of sale distribution of consumer finance to consider whether it is more appropriate for, say, the retailer to be the QFE in respect of its employees or for the product provider to be the QFE in respect of the retailer's employees as agents of the product provider.
71. Those contemplating QFE status will need to consider a number of factors, including the costs and liability associated with the regime and what the practical efficiencies might be for the entity and its advisers in terms of registration, authorisation and supervision. Costs will include not only fees and levies under the Act but also the business costs involved in establishing and maintaining the requirements to be a QFE. For an entity that does not already have the practical and financial capacity to supervise its own advisers, the costs of meeting the requirements to become a QFE may be material. Similarly, if a firm is more in the nature of a group of individuals, with the firm not in practice adding any extra layer of responsibility, there may not be any practical efficiencies to be gained through the QFE regime.
72. There may, however, be benefits to establishing and maintaining the requirements to be a QFE, for example, centralising the management of regulatory risk which advisers face and any associated reputational risk their employer or principal may face.

Becoming a QFE

73. An entity is eligible for QFE status if the Commission is satisfied that:
    1. it is registered or is entitled to be registered;⁴ and
    2. it is not debarred from applying for QFE status; and
    3. on the grant of QFE status and at all times while a QFE, it has the capacity to, and will,-
       1. discharge its obligations under the Act; and
       2. comply with the terms and conditions (if any) of the grant of QFE status.
74. To become a QFE an entity must therefore satisfy the Commission that it can and will ensure appropriate standards are met and maintained. This is largely a question of capacity - whether there are processes in place to identify training needs and to train and monitor employees and agents, and sufficient resources applied to ensure that those processes are effective. This amounts to whether an entity has the practical and financial capacity to supervise its own advisers. We envisage this involving an examination of systems and processes on the one hand and the culture of the entity on the other.
75. A prospective QFE must be able to demonstrate that it has policies and effective procedures to address and maintain the following:
    1. competence of employees and agents;
    2. conduct of employees and agents;
    3. capacity of organisational processes and arrangements;
    4. compliance and risk management;
    5. compensation arrangements;
    6. culture, ethics and governance;
    7. communication with / disclosure to clients;
    8. conflicts of interest management; and
    9. complaints management.
76. We will be developing guidelines detailing the application process and setting out what we will require to support an application, based on the above matters.
77. QFE status will be granted for a specified time and may be subject to terms and conditions.
78. Applicants who are not granted QFE status have a right of appeal to the District Court.

Competence and standards of professional conduct for QFE Advisers

79. The overarching purpose of the Act is underpinned in particular by the obligation for individual advisers to exercise the care, diligence, and skill that a reasonable financial adviser would exercise in the same circumstances, taking into account the nature and requirements of the financial adviser's client and the nature of the service performed for the client. A QFE will be responsible for ensuring that its advisers comply with this obligation. An important aspect of that will be ensuring that its advisers are competent.
80. The general obligation to exercise due care, diligence and skill is objective (i.e. what the "reasonable" financial adviser would do). However, the steps a QFE takes with a view to its advisers meeting that obligation are subjective and, ultimately, only a court can rule on whether those steps meet the standard. It is open to industry to develop a common understanding of the standard applied by the "reasonable" financial adviser. A key aim of the QFE framework will be to work with industry to establish common standards that are consistent with the overarching purpose of the Act.
81. As discussed in the recent Securities Commission Staff Paper on AFA Competence (see www.seccom.govt.nz), the National Qualifications Framework (NQF) now includes unit standards for financial advisers. We plan to explore with potential QFEs how they might voluntarily map their training and competence arrangements to NQF standards. Our objectives here are to standardise skill levels, make training provision more competitive and accessible, promote portability of qualifications, reduce compliance costs and simplify regulation. We anticipate that this mapping exercise could be incrementally undertaken by QFEs over the next two to three years.

Disclosure by QFEs

82. The Financial Advisers Act provides for regulations to prescribe the disclosures to be made by financial advisers and QFEs. For registered (but not authorised) financial advisers and authorised financial advisers the regulations may specify the form and content of disclosure. The Ministry of Economic Development ("MED") convened an industry working group on financial adviser disclosure and will shortly issue a discussion document on the content of the disclosure regulations.
83. For QFEs, the regulations may specify the form and some content⁵ of disclosure, and may further provide for additional disclosure requirements to be set out in a QFE's terms and conditions. To the extent that any disclosure requirements are imposed through QFE terms and conditions, we expect they will be consistent with the approach taken in the regulations to individual financial adviser disclosures (particularly to facilitate comparability), adjusted where necessary to reflect the nature and context of the QFE's business.
84. For example if a QFE is more in the nature of a small firm of individual advisers then disclosure about the individual adviser is likely to be more relevant whereas for a large institution disclosure relating to the institution may be more relevant.

Disclosure by wholesale financial advisers and research financial advisers

85. The Commission may also grant exemptions in relation to financial adviser disclosure obligations if it is satisfied that compliance costs would be unreasonable or would not be justified by the benefits of compliance. Two areas that are likely to be relevant to QFEs here are advice to wholesale customers and advice given by research staff for frontline advisers to use. This may apply not only to advisers covered by a QFE's designation but also to AFAs employed by a QFE. We note that advisers in these areas would still need to comply with their other financial adviser obligations but that alternative disclosure requirement may be warranted.

Footnotes

4. Note, however, that to be a QFE an entity needs to be registered and have been granted QFE status.
5. QFE disclosure regulations may prescribe disclosure in relation to dispute resolution and whether the QFE provides any other licensed service. Further disclosure requirements may be set out in the QFE's terms and conditions.