CoFI regulations issued - prohibition on target-based sales incentives clarified and licensing fees set

05 July 2023

New regulations, including the treatment of volume or value target-based incentives and setting the licencing fees, were issued in June, and will become effective on 31 March 2025 when the Conduct of Financial Institutions (CoFI) regime commences.

Substantial changes have been made as a result of last year’s consultation. These may require financial institutions to make some adjustments to their CoFI readiness programmes, in particular both financial institutions and intermediaries will need to ensure that any incentive arrangements (existing and new) that will apply on and after 31 March 2025 comply with the new prohibitions.

The finalised regulations are available here

Key changes

The changes should make the application of the volume or value targeted incentives prohibition clearer and confirm that it will apply to existing incentive agreements entered into before 31 March 2025.  

  • The prohibitions on financial institutions and intermediaries offering or giving ‘prohibited incentives’ no longer apply to all employees - only those who are involved in the provision of a financial institution’s relevant services or associated products and who have direct contact with consumers or persons who are acting on the consumer’s behalf, and their ‘immediate managers’;
  • The ‘prohibited incentive’ definition has been narrowed: it applies only where a person’s entitlement to the incentive (or the nature or value of the incentive) is determined in any way by a ‘direct’ reference to a target or other threshold that relates to the volume or value of the relevant services or associated products (the definition in the previous exposure draft included ‘indirect’ references);
  • The ‘prohibited incentive’ definition’s scope has been clarified by the finalised regulations specifying that:
    • An immediate manager’s incentive is a ‘prohibited incentive’ if the manager’s entitlement, or the nature or value of the incentive, is determined or calculated in any way by reference to a relevant employee’s performance, and that performance is assessed in any way by a direct reference to a target or other threshold that falls within the scope of the ‘prohibited incentive’ definition; and
    • The definition will not apply merely because the target or threshold relates to market share, profit, any other similar measure of financial performance, or the incentive is subject to a limit or cap.
  • New exclusions from the ‘prohibited incentive’ definition have been inserted for incentives:
    • Determined or calculated on a linear basis only, provided that they do not fall within the ‘prohibited incentive’ definition’s scope (these were previously excluded only by way of an example);
    • Offered or given by financial advice providers (who are not financial institutions) to their employees if the employee receives a monetary benefit which is not an incentive (such as a salary) for the services and also receives an incentive determined or calculated on a linear basis and by ‘only one direct reference’ to a volume or value target or threshold (such as a flat rate commission with a cap); and
    • Where the target or other threshold relates to the volume or value of relevant service or associated products provided to wholesale clients only (and in no way relates to the volume or value of services and products provided to retail clients).
  • The application of the regulations to agreements entered into before 31 March 2025 has been specified:
    • The ‘prohibited incentives’ prohibition will apply to prohibited incentives offered, given or payable on or after 31 March 2025, including under agreements that were entered into before 31 March 2025, but will not apply to incentives that are given, paid or payable before 31 March 2025 or that a person has become entitled to before 31 March 2025; and
    • The regulations permit a person who is prohibited from receiving a prohibited incentive under an agreement entered into before 31 March 2025 to exercise any right under that agreement to terminate or cancel the agreement in certain circumstances.

Other matters

The regulations also address matters beyond incentives, either flagged in the CoFI Act or decided by Cabinet. These include:

  • The exclusion from the CoFI regime of financial services offered to controlled entities of wholesale clients (even where the controlled entity may be a retail client);
  • How information about a fair conduct programme must be provided in response to a request under section 446H(1)(b) of the Financial Markets Conduct Act 2013 (the FMCA);
  • The terms and conditions that Lloyd’s underwriters must comply with to qualify for the CoFI licencing exemption, along with the requirements for Lloyd’s managing agents’ fair conduct programmes and how they are to make information about their programmes publicly available; and
  • Insurance contracts will be declared “financial products” for the purposes of the fair dealing rules in the FMCA (this will make it clear that conduct in relation to an insurance contract is prima facie a matter for the FMA, rather than the Commerce Commission under the Fair Trading Act 1986).

Licence fees

The fees for obtaining a financial institution licence required when CoFI comes into force will be $1,024.93 plus:

  • Fees charged on the hourly basis specified in Part 2 of Schedule 1 of the Financial Markets Conduct (Fees) Regulations 2014 for hours exceeding 6.75 (these fees are either $230.00 or $178.25 per hour depending on the type of FMA Board member or employee carrying out the work); and
  • A $614.95 fee for each entity that is proposed in the application to be an authorised body under the licence.

Our comments

As we flagged in our commentary on the draft regulations, the incentive prohibitions are on top of the wider obligation that fair conduct programmes must include effective policies, processes, systems and controls for designing and managing incentives to mitigate or avoid actual or potential adverse effects of incentives on the interests of consumers, so far as reasonably practicable. This means that financial institutions may choose to limit their incentives further than just excluding those which are prohibited, depending on their assessment of the effects of the other incentives they offer.

The finalised incentive regulations are an improvement on the draft regulations. However, while the changes made to the finalised regulations should make the prohibited incentives more commercially workable, in our view they do not go far enough.

MBIE unfortunately was not persuaded to specifically exempt genuine training invitations and the provision of customer-friendly advice tools from the prohibitions, or to permit volume or value targets or thresholds within balanced scorecards with conduct gateways and clawbacks.

It is acknowledged that these benefits give rise to boundary issues, but the chosen absolute prohibition in these respects risks “losing the good with the bad”. More targeted restrictions may have provided overall better consumer outcomes.  

MBIE also did not take the opportunity to insert a desirable clarification that the incentives prohibitions for insurance brokers who give financial advice, applies solely to consumer sales (and not to sales to other retail clients), like the prohibition for insurers, creditors and other non-financial service providing intermediaries. Nor did MBIE exclude senior managers who may have immediate reports who have occasional direct consumer contact that is ancillary to the sale of products and services (for example, complaints or other escalated matters).

While intermediaries who are financial advice providers will welcome relief from the new employee salary/commission combination exclusion, this exclusion is quite narrow and does not cover independent contractors in the same way.

There is still a while before the regulations become effective, and so, if there is a will, changes could still be made. In the meantime, financial institutions will be preparing their fair conduct programmes and considering subsequently making applications for their licences which, when granted, will come effective on 31 March 2025.

Chapman Tripp is able to help with these steps, and our team is very familiar with the policies, processes, systems and controls suitable for inclusion in a fair conduct programme.

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