2020 Litigation Forecast - Financial services and insurance: further regulation looming
2019 has seen continued focus on conduct and culture-related matters for the Financial Services sector, with legislative and regulatory change signalled following the FMA and RBNZ 2018-2019 banking and life insurance Conduct and Culture Reviews and the fallout from the Australian Royal Commission.
In 2020, we expect ongoing enhanced scrutiny of financial institutions’ activities and their efforts to put good customer outcomes at the heart of their businesses. In addition, the AML/ CFT regime is now fully implemented. We expect the supervisory bodies, RBNZ, FMA and Department of Internal Affairs (DIA) will continue their strong focus on enforcing this regime.
Regulatory change and transition
The appetite for regulatory oversight of the financial services sector has increased over the past 18 months, as a result of the various reviews undertaken both in New Zealand and Australia. We are now in a transition phase, with regulatory and legislative changes looming in a number of respects.
Financial markets conduct regime to come:
Following consultation in mid-2019, in September 2019 the Government announced a planned new financial conduct regime to address perceived gaps in regulatory oversight of financial institutions and their intermediaries, and to reduce the risk of harm to consumers.
A Financial Markets (Conduct of Institutions) Amendment Bill was drafted and introduced to Parliament in mid- December 2019. The exact timing for implementation is not yet clear, and regulations will also need to be drafted to implement the new regime.
Key aspects of the new regime include changes to the Financial Markets Conduct Act 2013 (FMC Act) to:
- Create a licensing regime (under the FMA) for registered banks, licensed insurers and non-bank deposit takers (such as credit unions) who provide ‘relevant services'.
- Require licensed institutions and intermediaries to comply with a ‘fair conduct principle', to treat customers fairly, including by paying due regard to their interests. This involves: – Requiring financial institutions to establish, implement and maintain an effective fair conduct programme through their policies, processes, systems and controls throughout every part of their business. – Taking all reasonable steps to comply with the fair conduct programme. – Meeting obligations to ensure their intermediaries comply with their fair conduct programme.
- Require financial institutions and intermediaries to comply with regulations to be introduced in due course relating to incentives based on volume or value targets.
- Protect employees and agents who report a breach of the FMC Act or the fair conduct principles to the FMA.
“[The Conduct and Culture] reviews by the [RBNZ and FMA] have also highlighted other problems in the banking and insurance sectors, which include weak systems for managing conduct risks and ensuring good conduct is a priority in their business. However, this new principles-based regime leaves much uncertainty about precisely how a fair conduct programme must operate and much of the detail of the Bill has been left to regulations which are yet to be drafted.”
Commerce and Consumer Affairs Minister Kris Faafoi, 25 September 201913
Penalties to align with maximum levels for civil liability
The pecuniary penalties for breaches of the new duties will align with the maximum levels for civil liability already in the FMC Act, not exceeding the greater of:
- The consideration for any relevant transaction
- Three times the amount of the gain made or loss avoided, and
- $1 million for an individual, and $5 million for a body corporate.
The Bill provides, however, that no-one can be liable for more than one pecuniary penalty for the same conduct, and that multiple pecuniary penalties cannot be imposed on a person for the same conduct under the FMC Act, Fair Trading Act, and Credit Contracts and Consumer Finance Act.
Director and executive accountability to be strengthened
Another key development in mid-December 2019 was the announcement by the Government of its intention to increase the accountability of directors of deposit-taking institutions, as part of Phase 2 of the Reserve Bank Act Review.
There will be a third round of consultation in early 2020 regarding the design and details for this, but at present the proposal is to impose positive duties on directors, such as:
- the need to ensure the entity is run in a prudent manner,
- acting with honesty and integrity, and
- dealing with the RBNZ in an open and transparent manner.
Enforcement would be under a civil liability framework, with criminal sanctions applying only where there is clear intent or recklessness by directors.
Development of an ‘executive accountability regime’ is also on the cards, to cover deposit takers and insurers licensed by the RBNZ and FMA. While options are still to be developed, the intention is to bring New Zealand broadly into line with the regimes in Australia (Banking Executive Accountability Regime – ‘BEAR’) and the U.K. (Senior Managers & Certification Regime).
2019 saw other changes to the architecture of financial services legislation, which are part of a market wide focus on conduct that will continue into next year.
- The Financial Services Legislation Amendment Act (FSLAA) introduces a new regulatory regime for financial advice, that will come into effect on 29 June 2020.
- A new Code of Conduct for Financial Advice has been approved, also to come into effect in June 2020.
- Draft regulations for financial advice providers’ disclosure obligations were released and consulted on in late 2019 and expected to be finalised in early 2020.
Insurance contract law is also set to undergo change
In December 2019, the Government announced proposed reforms following consultation on an Options Paper. The proposals include:
- Strengthening consumer protections against unfair contract terms in insurance contracts.
- Reforming the disclosure obligation to require consumers to take ‘reasonable care not to make a misrepresentation' (effectively, to answer any questions asked truthfully and accurately).
- Ensuring that insurers respond with ‘proportionate consequences' when customers fail to disclose material information or make a misrepresentation.
- Codifying the duty of utmost good faith.
In terms of scrutiny, the FMA is to be given extended powers to monitor and enforce compliance with these new requirements, with a resulting overlap in jurisdiction with the Commerce Commission around unfair contract term provisions regarding financial products and services.
An exposure draft of the Bill is to be released in mid-2020.14
“When there are serious breaches and systemic non-compliance we are willing to take strong regulatory action. It is important that we take regulatory action when there is a risk that criminals are exploiting New Zeland businesses to launder the proceeds of crime.”
Mike Stone, Director AML Group, Department of Internal Affairs, 17 October 2019
AML/CFT enforcement to continue
On 1 August 2019, the final categories of reporting entities, the Racing Industry Transition Agency and high-value dealers, became subject to compliance under the AML/CFT regime. The regime is now fully rolled-out, and we have seen significant enforcement activity taking place, which is expected to continue into 2020.
The first trial for criminal offences under the AML/CFT Act took place with a money remitter, Jiaxin Finance Ltd, and two individuals found guilty in November 2019 of criminal offences relating to 311 transactions with a total value of around $53 million. They will be sentenced in 2020 for:
- failing to conduct customer due diligence (knowingly or recklessly, which made this a criminal offence); and for
- failing to keep adequate records relating to a suspicious transaction, and to report a suspicious transaction (both under the standalone criminal offences).
One of the individuals was also found guilty of structuring a transaction to avoid the AML/CFT requirements.
While there is commonality between some conduct that amounts to civil breaches and that which is a criminal offence, we expect the AML/CFT supervisory agencies will reserve criminal proceedings for more serious examples.
The Department of Internal Affairs also obtained judgment in October 2019 in a civil proceeding launched in 2017 against Auckland based money remitter Jin Yuan Finance Ltd (Jin Yuan). Jin Yuan had repeatedly breached AML/CFT compliance requirements, including failing to conduct customer due diligence; failing to adequately monitor accounts and transactions; failing to report suspicious transactions; and failing to keep records.
The DIA had engaged with Jin Yuan extensively over a number of years, and the Court inferred its civil liability actions were intentional and its behaviour misleading. Jin Yuan was ordered to pay a pecuniary penalty of $4 million, including a 15% discount for admitting liability.
During 2019, the DIA also launched two civil proceedings against money remitters – OTT Trading Group Limited and MSI Group Limited.
The FMA and DIA both issued formal warnings to reporting entities under their respective supervisory jurisdictions. While the RBNZ did not issue any warnings to banks in 2019, it signalled to banks it considers the AML/CFT regime is maturing and its appetite for taking more formal enforcement action increased from 1 September 2019.
Ongoing heightened enforcement and scrutiny
While the FMA has not taken a ‘Why not Litigate' approach adopted by ASIC in Australia (which saw a 20% increase in the number of ASIC enforcement investigations between June 2018-June 2019), the FMA has nevertheless had a fairly busy enforcement year in 2019, necessitating an increase in its funding for 2019/20.
The increased mandate for the FMA under the new Financial Markets Conduct regime will also require further funding, which is still to be determined. The FMA did signal in its 2019 Annual Report a continuation of a ‘risk-based and proportionate’ approach to enforcement generally, but with a more robust approach, with ‘significant consequences’ to be taken in areas where improvement has been identified as necessary. This includes continuous disclosure, financial advice and AML.
Financial entities can therefore expect ongoing heightened scrutiny, and enforcement action taken to those who lag behind expectations.
There are also plans for an increase in the supervision and enforcement tools available to the RBNZ. The Government announced in December 2019 – as part of Phase 2 of the Review of the Reserve Bank Act – its plan to increase powers for the RBNZ, to:
- permit on-site inspections by the RBNZ of any licensed deposit taker;
- provide a broader suite of formal enforcement tools, potentially including statutory public notices, infringement fees, enforceable undertakings and civil penalties (further policy work will take place to identify which is required); and
- issue directions to a deposit-taker and enable de-licensing without ministerial involvement.
While these plans may take some time to develop, implement and resource, institutions can generally expect an increasingly intensive approach to supervision from the RBNZ, with greater scrutiny of compliance, and in due course greater power to punish breaches.
Conduct will be prioritised by the Council of Financial Regulators
Notably, conduct and governance is also one of the workstream priorities for the Council of Financial Regulators for 2020, to be led by the FMA.
The new conduct regime will mean some overlap with existing regulations and the respective regulators’ spheres of influence. In particular, the new financial conduct regime will have some overlap with the Credit Contracts and Consumer Finance Act 2003 and financial advice regime. This will need to be taken into consideration as the new regime is developed, and ultimately there will need to be co-ordination between the FMA and the Commerce Commission around enforcement.
All in all, those in the financial services sector should generally expect more regulatory oversight and interaction going into 2020 – a position that is unlikely to go away anytime soon.