This article reflects the personal views of the authors, Lloyd Kavanagh (Partner), and Elise Plunket (Solicitor), and not necessarily those of MinterEllisonRuddWatts or any of its clients. Its purpose is to catalyse an industry discussion as to how the regulation of financial services in New Zealand can be improved with the objective of promoting fair, efficient, and transparent financial markets.

Introduction

The financial services sector represents a significant part of the New Zealand economy, and should be a large contributor to economic growth. However, achieving such growth is dependent upon a regulatory structure which promotes innovation and flexibility in financial markets, avoids unnecessary compliance costs, and facilitates the development of fair, efficient and transparent financial markets. At the same time, a regulatory structure must provide for the informed participation of businesses, investors, and consumers in financial markets [1].

As the regulatory environment has evolved in New Zealand, the above objectives have not always been achieved. In part, this is because there are several regulators and a confused regulatory model. This is despite much of the commentary and literature referring to the “twin peaks model”, and claiming it is the structure that New Zealand employs [2].

The prize to be achieved from simplifying and standardising the regulation of the New Zealand financial services sector is significant. New Zealand’s financial services sector should be a key contributor to the development of a “weightless” economy diversifying our foreign earnings away from the traditional sectors upon which the economy is overly reliant.

The twin peaks model and New Zealand’s attempt

The twin peaks model

The twin peaks model was developed in Australia as a result of recommendations from the Wallis Inquiry in 1997 [3]. The ‘objectives-based’ model is highly regarded, and has become popular further afield as a result of a global movement away from the sectoral or institutional model of regulation [4]. Those latter approaches (which see entities regulated according to the sector in which they operate or their legal form), fell out of favour as they presuppose a clear separation of the different sectors, and/or that the legal form of an entity is a direct reflection of its activities [5].

The essential feature of the twin peaks model is to recognise two equal and independent peaks:

• a conduct regulator which has responsibility for the conduct of financial institutions – in Australia, the Australian Securities and Investments Commission; and
• a prudential regulator which has responsibility for ensuring the systemic strength of the financial system – in Australia, the Australian Prudential Regulation Authority (APRA).

Despite it being severely tested in Australia with the HIH Insurance collapse in 2001 and the GFC, the model has maintained its resilience, and there has been no serious consideration of another model [6].

Crucial to the success of the twin peaks model is the notion that both regulators are separate and equal in power and importance, and that neither should play second fiddle to the other. The model recognises that if one of the two peak bodies is subordinate to the other, or they overlap in their responsibilities, either conduct or prudential strength will be secondary. It is therefore important that each entity has a clear mandate that promotes focus on its core tasks. Despite these separate mandates, and while the peaks must seek not to overlap, for the model to work there must be a degree of coordination and liaison channels so that the regulators’ actions are coherent [7].

Separate from the twin peaks, there also needs to be a strong competition regulator. For the model to be effective, the competition regulator needs to focus on ensuring that there is true competition between the regulated entities. Again, this competition regulator must focus on its own core mandate and not overlap with the conduct and prudential strength mandates - otherwise it will fail to promote adequate competition.

New Zealand’s approach

New Zealand acknowledges the twin peaks model [8], but in practice blurs the roles and responsibilities of each peak. When New Zealand introduced the model in 2008 - 2013, the Reserve Bank of New Zealand (RBNZ) was assigned the prudential role, and the Financial Markets Authority (FMA) was introduced as the conduct regulator. However, very different approaches were taken in creating each ‘peak’ regulator, and they have substantial overlaps as we explore further below.

Following the creation of the FMA, a new regulatory scheme was established, involving a wholesale restructure and legislated reform primarily in the Financial Markets Conduct Act 2013 (FMCA). Meanwhile, only small adjustments were made to the prudential regulation peak, and the RBNZ essentially continued its role with an extended mandate. This meant that some deficiencies with the existing system went unaddressed, and the opportunities that came with using a twin peaks model were not fully optimised [9].

Intermingling of the two peaks persists; both in legislated mandates, and in the expansive way they are applied in practice. The RBNZ may involve itself in aspects of the regime, for example, inquiries into the conduct and culture of financial institutions when those do not necessarily have prudential implications [10]. The FMA, while primarily focusing on conduct, may also involve itself in aspects of the capital adequacy of some of the businesses within its purview [11].

The position is further complicated by the Commerce Commission having a significant conduct regulation role in relation to financial services under the Credit Contracts and Consumer Finance Act 2003 (CCCFA), and under Part 1 of the Fair Trading Act 1986 (FTA) which is almost identical to Part 2 of the FMCA. In relation to the FTA, the FMA has the lead role in relation to financial services providers; however, the reality remains that there are two regulators which may take different approaches.

As a result, the relevant agencies have formed a collective referred to as the Council of Financial Regulators (CoFR) whose members include the RBNZ, FMA, Commerce Commission, MBIE, and the Treasury. While there is a role for CoFR in terms of coordination and liaison channels, it is operating more and more as a forum in which regulators adopt collective approaches and reduce constructive tension (which is one of the benefits of the twin peaks approach). Again, this further muddles our regulatory model, and detracts from the twin peaks approach.

A better regulatory landscape

New Zealand would benefit from a restructure of the financial services regulatory system so that it more clearly reflects a pure twin peaks model. The twin peaks model relies on the creation of regulatory bodies with ‘clear and precise remit[s]’ and a regulatory process ‘which is open, transparent and [publicly] accountable.’ [12] There should be no overlaps, and a degree of constructive tension between them. The changes outlined below will work towards creating this more well-defined and simplified system that will make doing business easier, without concessions for customers.

Commerce Commission refocused on competition (exiting financial services regulation):

Under a pure twin peaks model, the Commerce Commission should not be a conduct regulator in relation to financial services. Its current conduct role under the CCCFA, it is submitted, is a distraction from its primary competition role. Issues with the state of competition in New Zealand have been acknowledged by both major political parties in the recent election campaign as inhibiting productivity and innovation, and increasing the cost of living. Weak competition can contribute to a firms' mediocre management and performance [13]. One way to enable the Commerce Commission to focus on its competition role would be to move responsibility for the CCCFA to the FMA.

In relation to the FTA, this would involve amending it to make clear that it does not apply to financial institutions to the extent that they are subject to the comparable provisions under Part 2 of the FMCA, so that the FMA is the sole regulator for those entities. The Commerce Commission would retain its role under the FTA for other businesses. This more focused mandate of the Commerce Commission and delegation of fair trading by financial institutions to the FMA would promote the benefits of clarity that come with the twin peaks model.

RBNZ focused on prudential strength

Originally, under the Reserve Bank of New Zealand Act 1989 (BPSA) [14], it was clear that the RBNZ was focused only on monetary policy and the prudential supervision of banks. Then it was also given the roles of the prudential supervision of insurers under the Insurance (Prudential Supervision) Act 2010 (IPSA), and of non-bank deposit takers (NBDTs) under BPSA in 2008. It was finally rehomed in the Non-Bank Deposit Takers Act 2013 (NBDTA).

Even that blending of monetary policy with prudential supervision is a departure from a true twin peaks model - in Australia, prudential supervision has been split out into APRA, separate from the Reserve Bank of Australia (which retains monetary policy). It would be better for monetary policy outcomes if that approach had been followed in New Zealand. For the present, this blending may have to be accepted given it was reconfirmed only recently when the new Reserve Bank of New Zealand Act 2021 was passed, after the RBNZ fought hard to retain both roles.

The greater priority is that the RBNZ’s mandate has gradually expanded. As shown in its 2023 Report, the RBNZ is looking more and more at challenges such as conduct, governance, climate issues [15] and anti-money laundering [16]. For example, it took a lead role (along with the FMA) in the conduct and culture enquiries, which have only an indirect link to prudential concerns [17].

This all risks distracting the RBNZ from its core role of giving New Zealanders a focused prudential regulator. The RBNZ must be refocused on ensuring the prudential strength and resilience of systemically important institutions. This can be done to some extent under existing legislation by letters of Ministerial expectation – the constraints which apply in relation to monetary policy do not apply in relation to the RBNZ’s other activities [18].

The recently enacted Deposit Takers Act 2023 (DTA) will replace and consolidate BPSA and the NBDTA supervision regimes – largely from 2027 [19]. The DTA should be reviewed thoroughly to ensure that the powers under that regime do not go any further than is necessary for the systematic prudential purpose, and that additional cost and compliance burdens are carefully considered. In particular, one should be alert to the RBNZ’s expansion of its role beyond systemically important deposit takers to non-systemic institutions.

The RBNZ is also currently seeking to significantly expand its powers in relation to insurance in the omnibus IPSA consultation [20]. The existing IPSA regime is largely fit for purpose and does not require the significant additional powers which the RBNZ is seeking under that regime. As stated in the second reading of the IPSA Bill [21], “in a light-handed way, it provides for the delivery of regulation so that we do not mire the industry in a compliance mentality”. Proposals for the new regime move away from this, and bring into effect a more extensive level of regulatory supervision and intervention [22].

FMA focused on conduct

Appropriately, the FMA is largely focused on being a conduct regulator, primarily under the FMCA – which is generally acknowledged as a successful reform, as well as the other financial markets legislation listed in Part 1 of Schedule 1 of the FMA Act 2011 [23]. It should not be given additional roles as they inevitably distract from the core focus. With that approach, the FMA should become the sole conduct supervisor for the financial sector.

Within that mandate there is still work to do, and the FMA should be encouraged to focus its energy on true miscreants when it comes to enforcement. The FMA has applied significant resources and capability to its enforcement function, and has indicated that it may be more willing to bring an action in order to clarify the law and provide certainty for markets and consumers [24]. That is appropriate, so long as the focus is on cases that involve serious threat to New Zealand investors, or the integrity of New Zealand's financial services sector.

However, there are signs of over-reach that are concerning; one example is the FMA’s recent move to focus on what it refers to as “customer outcomes”, rather than compliance with obligations. Of course, we are all in favour of good outcomes. However, if what constitutes a good outcome depends on the FMA using its own judgement as to what is good for investors, and substituting this for the informed decisions of investors, or decisions of the issuers reflecting their understanding of legal requirements, this will lead to ambiguity and unintended consequences.

Other roles

Other specialist roles of the FMA and RBNZ that are not related to conduct or prudential strength should be consolidated into a single entity. For example, in relation to the Anti-Money Laundering and Countering the Financing of Terrorism Act 2009, both the FMA and RBNZ have supervisor roles – alongside the Department of Internal Affairs.

The current model of distributing responsibility across three entities risks further confusion and lack of focus by the FMA and the RBNZ on their core roles. In addition, it results in ambiguity as to the different treatment of entities in competing sectors, and inefficiency through duplication of hierarchies. The solution to this challenge is simple. The AML supervisor role should be consolidated into a single entity - an “NZTRAC” modelled on the Australian AUSTRAC.

What about the Conduct of Financial Institutions (CoFI) regime?

The FMCA currently provides for a new conduct regime (referred to as CoFI) for retail banking, deposit-taking and insurance, to commence in March 2025. Below are some observations on the proposed regime in light of statements made in the recent election campaign.

Some form of conduct regulation is appropriate for those sectors. The International Monetary Fund said in its review of New Zealand’s financial sector that there is “a need to enhance conduct regulation in the insurance sector” [25], and the same may be said of banking. The FMA is the appropriate repository for that role, as this is consistent with a true twin peaks model as outlined above.

The key features of the regime, as currently embodied in the FMCA, are requirements on banks, insurers and NBDTs to:

• be licensed by the FMA in respect of their conduct towards consumers; 
• comply with a “fair conduct principle” to treat consumers fairly;
• establish, maintain and implement a “fair conduct programme” (FCP) to give effect to the fair conduct principle and take all reasonable steps to comply with the programme; and 
• comply with regulations that ban target-based sales incentives, and regulate other types of incentives.

Licensing

CoFI licensing:

• There is a legitimate role for the conduct licencing, and it would be more effective than reliance on Part 2 of the FMCA alone.
• The role is correctly located with the FMA. To give that role to the RBNZ would further blur the already unclear application of twin peaks in New Zealand.
• However, much of the criticism made about CoFl licencing is legitimate and would be addressed by consolidating it with the current licencing regime under the FMCA, and reducing prescription in relation to the FCP. Consolidation would be an improvement for that regime in itself.

Currently, Part 6 of the FMCA provides for separate licences for separate activities (even if conducted by the same entity) and the requirements of the licences overlap significantly. For example, it is possible that a single financial institution such as a bank would have separate licences for being a financial advice provider (FAP), a discretionary investment management service provider (DIMS), being the manager of a managed investment scheme (MIS), and issuing derivatives. CoFI licences will also be issued under Part 6 of the FMCA once that regime is in force, and may be required for the same financial institutions that already have multiple licences. Each of these licensing regimes have their own requirements and application guidance, despite the fact that a majority of the issues they address are the same.

This level of overlap creates unnecessary duplication for many organisations in the regulation of financial services. To address this, promote efficiency, and encourage innovation, the regime could easily be reformed by providing for a single licence to be issued under Part 6 to any entity subject to any part of the financial services regulation regime, where the common provisions would be consolidated under a single regime with common expectations.

This single “New Zealand Financial Services Conduct licence” would replace all the various product and service licences that currently exist with a single licence that covers CoFI, FAP, DIMS, MIS, etc. If necessary, there could be categories of additional requirements for specific product or service lines, with provisions that turn on and off depending on what kind of financial service and/or product is being offered. This would create a simplified licensing regime that still recognises that different products and services should be subject to regulation that caters to those differences.

The nature of these changes would require only minor amendments to the FMCA and FMC Regulations to integrate the regimes. This would remove much of the bureaucracy and confusion that occurs under the current regimes (which will only become worse once CoFI comes into force), while maintaining a system of licencing that acknowledges the differences between the various financial services and products.

CoFI: Fair conduct principle and FCP

The core of the fair conduct principle is to be applauded. However, elements that relate to “paying due regard to [consumers’] interests”; “acting ethically, transparently and in good faith”; and “not subjecting consumers to unfair pressure or tactics or undue influence” for the most part already exist under the existing regimes for FAP, DIMS, MIS, and derivatives licence holders, and have not given rise to significant problems. The fair conduct principle is also defined as “including” these elements, rather than being limited to them. This means that what is required by the fair conduct principle is effectively unconstrained by legislative parameters – introducing indeterminacy into the regime.

Further, the requirement to “ensure the services and products that the financial institution provides are likely to meet the requirements and objectives of likely consumers” may go further than is needed. It requires institutions to take a paternalistic view and substitute their judgement of what is good for investors, rather than letting investors make these assessments independently. This will potentially result in similar issues to those that have arisen under the CCCFA, where “responsible lenders” have considered they are required to refuse to lend to customers, who on an informed basis are confident in their borrowing decisions.

To avoid overregulation of the industry, the requirements to be included in the FCP should be reduced. In particular, much of the detail currently prescribed in the CoFl regime should be removed. Specifically, section 446J should be substantially repealed and merely say:

446J Minimum requirements for fair conduct programme

The fair conduct programme must be in writing and include effective policies, processes, systems, and controls to give effect to the fair conduct principle, as the institution reasonably considers is required in the context of its business.

Responsibility should be left with the institution as to how it gives effect to the fair conduct principle, having regard to the nature and scale of it's own business. Allowing institutions more flexibility as to the scope and content of the FCP they choose to implement would result in outcomes which are more efficient and allow greater innovation.

Ban on target-based sales incentives

Whether or not the ban in its current form is required for those whose distribution channels are not subject to the FAP regime, it is not needed for those who are already operating through FAP licensed channels and are subject to that regime. There is no evidence of a problem to fix in relation to distribution via FAP channels because the FAP regime already prescribes appropriate requirements.

The expanding role of “guidance”

The final area of concern is the apparent scope creep of “guidance”. The purpose of guidance should be to illustrate to regulated financial institutions one method by which they can achieve compliance with the requirements in legislation and regulation. It may also indicate minimum standards. 

However, it should not be elevated to the level of being effectively tertiary legislation. If it is perceived either by the regulator or the regulated community to amount to de facto regulation, which must be followed, then the effect may be to stifle innovation and discourage financial institutions from finding their own solutions that suit both their own businesses and their own customers.

Conclusions

Financial services regulation in New Zealand is becoming increasingly complex, which is increasing the cost of compliance and risks, reducing innovation and creating entry barriers for new entrants.

Part of this complexity is due to overlap in the mandates of the three core regulators, which could largely be resolved through a re-clarification of their mandates according to the twin peaks model. The adoption of the changes suggested in this paper would assist in striking a balance between consumer protection and leaving room for businesses to innovate and make their services available to all New Zealanders.

References

[1] See the purpose of the Financial Markets Conduct Act 2013 as set out in sections 3 and 4.
[2] https://www.treasury.govt.nz/sites/default/files/2018-10/rbnz-review-bp2-separating-prudential-regulation-supervision.pdf and https://www.rbnz.govt.nz/-/media/decafd62262042ddaee842ab322fe8db.ashx?sc_lang=en 
[3] https://www.accc.gov.au/system/files/The%20Wallis%20Report.doc.
[4] Godwin, A., & Schmulow, A. (Eds.). (2021). The Cambridge Handbook of Twin Peaks Financial Regulation (Cambridge Law Handbooks), page 17.
[5] A Jurisdictional Comparison of the Twin Peaks Model of Financial Regulation Andrew Godwin, Timothy Howse and Ian Ramsay https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2905458, page 2.
[6] A Jurisdictional Comparison of the Twin Peaks Model of Financial Regulation Andrew Godwin, Timothy Howse and Ian Ramsay https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2905458, page 1.
[7] A Jurisdictional Comparison of the Twin Peaks Model of Financial Regulation Andrew Godwin, Timothy Howse and Ian Ramsay https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2905458, page 4.
[8] https://www.rbnz.govt.nz/-/media/decafd62262042ddaee842ab322fe8db.ashx?sc_lang=en and https://www.fma.govt.nz/assets/Consultations/Financial-Institutions-Summary-of-key-themes-standard-conditions-1.pdf .
[9] Godwin, A., & Schmulow, A. (Eds.). (2021). The Cambridge Handbook of Twin Peaks Financial Regulation (Cambridge Law Handbooks), Page 93.
[10] https://www.rbnz.govt.nz/hub/news/2018/05/financial-services-conduct-and-culture-review.
[11] https://www.fma.govt.nz/consumer/investing/types-of-investments/bank-regulatory-capital/.
[12] Godwin, A., & Schmulow, A. (Eds.). (2021). The Cambridge Handbook of Twin Peaks Financial Regulation (Cambridge Law Handbooks), Page 96.
[13] Annual Report on Competition Policy Developments in New Zealand, OECD 2017 https://one.oecd.org/document/DAF/COMP/AR(2017)38/en/pdf and https://one.oecd.org/document/DAF/COMP/AR(2022)27/en/pdf.
[14] Renamed as the Banking (Prudential Supervision) Act 1989.
[15] https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/annual-reports/annual-report-2023.pdf.
[16] https://www.rbnz.govt.nz/regulation-and-supervision/anti-money-laundering-and-countering-terrorism-financing/aml-cft-guidance-and-resources.
[17] E.g. the cross-sector thematic review on governance which it undertook with FMA, which required enormous work by selected entities and resulted in output which told them little about what was expected from a prudential perspective. See https://www.rbnz.govt.nz/regulation-and-supervision/cross-sector-oversight/thematic-reviews/cross-sector-thematic-review-on-governance.
[18] https://www.rbnz.govt.nz/hub/publications/corporate-publications/letters-of-expectation/letter-of-expectations-2023.
[19] DTA will establish a new compensation scheme to protect deposits of up to $100,000 in each bank or other deposit taker, expected to go live from late 2024, however.
[20] https://www.rbnz.govt.nz/regulation-and-supervision/oversight-of-insurers/how-we-regulate-and-supervise-insurers/our-policy-work-for-insurer-oversight/review-of-insurance-prudential-supervision-act-2010.
[21] (29 July 2010) 665 NZPD (Insurance (Prudential Supervision) Bill – Second Reading, Peseta Sam Lotu-Iiga).
[22] https://www.minterellison.co.nz/insights/a-more-proactive-and-intensive-approach-to-sup-1.
[23] The other legislation listed in Schedule 1, Part 1 of the FMA Act is Auditor Regulation Act 2011, Financial Markets Infrastructures Act 2021, Financial Markets Supervisors Act 2011, Financial Service Providers (Registration and Dispute Resolution) Act 2008, Part 4 and Schedule 1 of the KiwiSaver Act 2006, and Sections 45U and 45V of the Public Finance Act 1989. However, the long list of other roles under legislation named in Schedule 1 Part 2 in many cases go beyond a pure conduct regulator role, including in particular the AML/CFT regime as discussed below. 
[24] https://www.minterellison.co.nz/insights/credible-deterrence-fma-enforcement-to-increase.
[25] https://www.imf.org/-/media/Files/Publications/CR/2017/cr17110.ashx, page 7.