The Government is proposing a principles-based set of duties backed by prescriptive regulation, where deemed necessary, and proactive regulatory supervision.
The Options Paper will inform the fast track legislation promised by the Government in response to the Hayne Final Report and to the reviews by the Reserve Bank of New Zealand and the Financial Markets Authority into the retail banking and insurance industries.
Submissions are due with the Ministry of Business, Innovation and Employment (MBIE) by 7 June 2019. The aim is to have the resulting Bill in the House this year.
“Financial institutions” for the purpose of the review are banks and insurers in their dealings with retail customers. But the term has been kept deliberately general to keep open the prospect of expanding the regime to KiwiSaver providers, Non-Bank Deposit Takers, other lenders etc.
To encourage a culture aimed at delivering good consumer outcomes, a set of “over-arching duties” would be established, with directors and senior managers personally liable for ensuring these were met. MBIE acknowledges that a downside of not being prescriptive can be uncertainty.
The proposed duties would include:
- a duty to prioritise the customer’s interest to the extent reasonably practicable (this may be supported by a code of practice to provide guidance on what is expected. It is recognised that compliance will create new compliance costs)
- a duty to act with due care, skill and diligence (this would extend the duty currently applying to financial advisers to all financial institutions and their staff)
- a duty to pay due regard to the information needs of customers and to communicate in a clear and timely way (this would be principles-based given the impracticality of prescription over the wide range of financial products)
- a duty to manage conflicts of interest fairly and transparently
- a duty to ensure that complaints are handled in a fair, timely and transparent manner. This may involve:
- recording all complaints to detect emerging trends
- reporting regularly to senior managers or committees
- escalating an issue to a team in another part of the organisation over a certain incidence threshold (e.g. 10 customers)
- developing a consistent and common definition of what a “complaint” is
- proactively raising staff and customer awareness of complaint and dispute resolution procedures, and
- a requirement to have systems and controls in place that support good conduct and address poor conduct. This may involve:
- developing a code of conduct and educating staff on what is expected of them
- prioritising investment to identify and record issues that may require remediation
- using lead indicators to monitor consumer outcomes
- enhanced controls and oversight of higher-risk products and distribution channels, and
- clear expectations from the board about the information they require in this area.
MBIE recognises that this will create costs for both the regulators and industry, and may require new infrastructure investment, particularly for financial institutions which have grown via acquisition and have a number of different legacy systems.
It is also recognised that it may blur the distinction between minimum standards and best practice – either operating as a disincentive for firms to strive for a higher standard, or leading to over-caution, “which could inhibit innovation”.
The recommendations on remuneration and incentives are:
- a duty to design arrangements which are likely to promote good consumer outcomes, and
- a ban on target-based reward systems, including soft commissions.
Both would apply to all monetary and non-monetary benefits available to internal staff and external intermediaries.
Other proposals are to:
- prohibit all in-house remuneration and incentives structures linked to sales measures
- regulate to impose parameters around the structure of commissions that can be paid to external intermediaries. Australia, for example, imposed an upfront commission cap of 80% on life insurance sales in 2018 which was reduced to 70% this year and will go to 60% next year, with a maximum trail commission of 20%
- create a duty on product manufacturers to take reasonable steps to ensure that the sales of its products are likely to lead to good consumer outcomes. Reasonable steps in this context might include: staff and intermediary training, monitoring and quality assurance and setting clear expectations on the information to be communicated to the customer with appropriate checks to ensure that this occurs.
Proposals to improve product design
Three options are proposed, one of which – banning certain products – is unlikely to proceed as MBIE has identified it as “not preferred”. The other two are to:
- give the regulator the power to ban or stop the distribution of products with particularly poor consumer outcomes (e.g., insurance policies with very low successful claims rates), and
- require manufacturers to identify the intended audience for products and distributors to have regard to that audience when placing the product. MBIE notes that this may be problematic and expensive to implement.
The Australians have already legislated for the last option above. The Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019, which commences on 5 April 2021, will require issuers of, and financial service provider distributors for, all but the most simple products in Australia to make an appropriate "target market determination" of suitability of financial products, with stiff penalties if the new requirements are not followed.
Resource the FMA to monitor and enforce compliance.
Introduce an entity level ‘conduct’ licensing regime – e.g. the Australian Financial Services licence covers organisational competence and compliance and the UK licensing process includes consideration of whether the firm is “ready, willing and organised to comply, on a continuing basis, with the requirements and standards under the regulatory system”.
Give the regulator a broad range of tools – e.g., public warnings, stop orders, direction orders, court injunctions, enforceable undertakings.
Strong penalties – e.g., three times the amount of the gain made or loss avoided, $1m for individuals, $5m in any other case.
Executive accountability. MBIE notes that this generally has four elements: a requirement on senior management to be capable and competent; clear lines of accountability for monitoring conduct; individual penalties for failure to meet agreed standards, and rules of conduct for senior executives.
Require whistleblowing procedures to be in place.
Require regular reporting about the industry – e.g., summary data on remediation activities, loss/claim ratios for insurance products, reasons for declined insurance claims, number of complaints etc.
Options specific to insurance claims
Although MBIE has now also released the option paper arising from the Insurance Contract Law Review, which we will comment on in a separate Brief Counsel, it has put two insurance specific recommendations into this review. They are:
- a duty to ensure claims are handled in a fair, timely and transparent manner, and
- a requirement to settle claims within a set time, with exceptions for certain circumstances.
Chapman Tripp comment
Many of the recommendations discussed above will contain cost implications which – taken together – may be significant. MBIE is upfront about this, acknowledging it at many points through the discussion document.
Our concern from the outset has been that the Government may over-reach, imposing requirements that, although well-intended, will suffocate dynamism and competition to the detriment of the consumer. This was a major theme in our commentary The Hayne report – be careful what you wish for.
Based on the proposals that are now in play, we think that there is a real risk of this happening. We urge you to engage in the consultation process so that the right balance is achieved between consumer protection and industry innovation.
For assistance preparing a submission, please get in touch with our contacts.