## cr17117 ## Source details **Canonical URL:** [cr17117](https://www.imf.org/-/media/files/publications/cr/2017/cr17117.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17117.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17117.pdf.json) --- ### Executive summary: key findings and policy recommendations - New Zealand’s capital market regulatory framework underwent a major overhaul since the last FSAP in 2004; many capital market players (including asset managers) were not licensed or supervised at that time. - The Financial Markets Authority (FMA) was established as the conduct regulator of the financial sector and a licensing regime for managers of Managed Investment Schemes (MIS) is now in place. - Retail offers of MIS are regulated and subject to governance, disclosure and eligibility requirements. - Supervision of the asset management industry has recently started and is still developing: - The FMA completed initial licensing of MIS managers under the new regulatory regime in December 2016 and is in the process of refining a risk-based supervisory approach. - The licensing process provided the FMA with sector insight to identify major risks for ongoing supervision. - Financial Markets Supervisors (private licensed entities) are now required for retail MIS and are expected to perform statutory supervisory activities, including monitoring valuation policies, custody, leverage and liquidity risk management. - Regulatory gaps and concerns: - Custody services are not required to be licensed in New Zealand; custodians are outside direct FMA supervision and are not subject to prudential requirements or ongoing supervision by any other authority. - Wholesale asset management activities fall outside the FMC Act perimeter because the regime is centered on funds offered publicly to retail investors. Limited data on the wholesale sector hinders assessment of related risks. - Supervisory approach recommendations: - The FMA should define its supervisory approach to asset management, giving significant consideration to the expectations placed on Supervisors and the risks of relying on them. - The FMA should ensure it retains direct oversight of areas relevant to sector stability and requiring technical or macro perspectives. - Monitoring of Supervisors should ensure consistent, high-quality supervisory work aligned with FMA priorities. - The FMA is engaged in systemic risk monitoring related to securities markets and asset management: - Strategic Risk Committee work to determine key strategic risks. - Participation in domestic and international cooperation forums, including the Council of Financial Regulators and the Trans-Tasman Emerging Risk Committee. - The FMA is undertaking a study on New Zealand’s wholesale markets to define its regulatory and supervisory role in wholesale asset management. ### Main recommendations on regulation and supervision of Managed Investment Schemes (Table 1) - Develop a framework for minimum requirements for valuation methodologies and pricing practices, including restricting the use of historic net asset value (NAV) and constant NAV. — Priority: Short-Term - Define Money Market Funds within regulation of MIS. — Priority: Short-Term - Ensure that MIS’ use of leverage is monitored to be able to determine its actual size and growth. — Priority: Short-Term - Require that the provision of custody services be subject to licensing and supervision. — Priority: Short-Term - Continue the pre-lodgment review of MIS offer documents and introduce the review of SIPOs and governing documents of MIS at the time of registration. — Priority: Immediate - Ensure that the supervisory approach to MIS managers places an emphasis on direct monitoring by the FMA (as opposed to exclusively through Financial Markets Supervisors) of aspects most relevant to financial stability. — Priority: Immediate - Continue to engage with Supervisors to ensure that they take a consistent approach to their supervision of MIS managers and that this is aligned with FMA priorities. — Priority: Immediate - Ensure an appropriate supervision of delegated functions and consider whether more stringent requirements for eligibility of delegates (including for cross- border delegation) are needed going forward. — Priority: Immediate - Continue to refine the coverage and format of data reporting in the MIS sector to ensure appropriate monitoring of the risks and an efficient analysis of the information. — Priority: Immediate - Consider the need to expand the perimeter of regulation to ensure an appropriate oversight of the wholesale asset management sector. — Priority: Short-Term - Note: Immediate = Within one year; Short term = 1–3 years. ### FMA mandate, governance, funding, and strategic priorities - Main objective: promote and facilitate the development of fair, efficient and transparent financial markets. - Established: 2011 as an independent Crown entity not required to have regard to government policy. - Governance: governed by a Board; members appointed by the Governor-General on recommendation of the FMA’s responsible Minister. - Funding: mix of industry levies and government contribution. - Notable funding change: the FMA’s responsible Minister announced on November 3, 2016 the government’s approval to a funding increase for the FMA of approximately 20 percent of its budget, to come from changes in levies of financial services providers. - Strategic Risk Outlook: seven strategic priorities: - (i) governance and culture; - (ii) conflicted conduct; - (iii) capital market growth and integrity; - (iv) sales and advice; - (v) investor decision making; - (vi) effective frontline regulators; - (vii) FMA effectiveness and efficiency. - Management responsibility: ensure priorities permeate the organization and guide disclosure, licensing, supervision and enforcement decisions. ### FMC Act framework, Registers and Supervisors - Regulated Offer Regime: - Offers not covered by Schedule 1 Exclusions require a Product Disclosure Statement (PDS) and Register Entry on the Disclose Register; KIS required in each PDS. - Governance requirements for MIS: governing document, a manager, a Statement of Investment Policy and Objectives (SIPO) and a Supervisor. - Eligibility: managers of certain MIS, Supervisors and derivatives issuers must be licensed. - Financial Markets Supervisors (Supervisors): - Regulated under the Financial Markets Supervisors Act 2011. - Main functions: protect investors’ interests and act on their behalf; supervise issuer/manager performance; monitor compliance with PDS, SIPO and governing document. - Powers: require information, engage experts, approve auditors, appoint receiver in certain cases, request winding up. - Supervisors receive regular reporting from MIS managers and custodians and act as primary custodians unless custody contracted out. - Registers: - Disclose Register: online register for offers of financial products and MIS under the FMC Act. - Financial Service Providers Register (FSPR): searchable online register of people and businesses that offer financial services; registration is not an official approval. ### Market structure, MIS AUM and concentration (key statistics) - KiwiSaver: - As at September 30, 2016, 2.67 million New Zealanders were members of KiwiSaver with funds invested in 30 KiwiSaver schemes of about $37.7 billion. - KiwiSaver schemes are managed by private KiwiSaver providers. - Other MIS AUM (as at September 30, 2016 unless otherwise noted): - licensed MIS managers manage approximately $32.6 billion invested in retail unit trusts; - about $22.5 billion invested in other registered superannuation schemes; - about $9.2 billion in cash management trusts (money market products). - Market concentration: - At December 1, 2016, there were 377 Registered MIS and 66 licensed MIS managers. - Total AUM of MIS managers were approximately $129 billion (as at September 30, 2016). - About 50 percent of assets invested in MIS are managed by the top three New Zealand MIS managers. - The top ten MIS managers manage about eighty percent of assets invested in New Zealand MIS. - Quantified tables (KiwiSaver AUM by asset class; September 30, 2016; Data for AUM of the 25 KiwiSaver schemes that are Registered MIS. Excludes the 5 Restricted KiwiSaver schemes with AUM of $675 million): - Australasian equities: $4,904.20 M — 13.24 percent of assets - Cash: $7,352.31 M — 19.86 percent of assets - International equities: $9,703.62 M — 26.20 percent of assets - International fixed income: $7,207.64 M — 19.46 percent of assets - Listed property: $1,688.38 M — 4.56 percent of assets - NZ Fixed interest: $5,489.89 M — 14.83 percent of assets - Other: $494.47 M — 1.34 percent of assets - Unknown: $0 — 0 percent of assets - Unlisted property: $189.16 M — 0.51 percent of assets - Total: $37,029.67 M — 100 percent of assets - Source: FMA. - Assets under Management by New Zealand MIS Managers (Number of MIS as of December 2016; AUM as of September 30, 2016): - Registered MIS: 377 — AUM $88,115 M - Wholesale MIS: No complete data — AUM $27,222 M - Restricted MIS: 109 — AUM $13,868 M - Total: 486 — AUM $129,205 M - Note: Wholesale MIS are not required to register and the FMA does not currently have data on the number of wholesale MIS in New Zealand. The wholesale AUM figure is taken from the RBNZ Managed Fund Survey and may include some funds managed on behalf of Registered MIS. ### Delegation, outsourcing and eligibility of delegates - MIS managers may delegate some or all functions while retaining liability for performance. - Manager obligations when outsourcing: - take all reasonable steps to ensure delegated functions are performed in the same manner as if performed directly; - monitor performance of delegated functions; - disclose delegated functions in the PDS and report changes in Quarterly Fund Update and/or annual report. - Regulatory approach: - Eligibility requirements for delegates are fairly light; emphasis is on managers’ oversight. - The FMA should consider whether more stringent eligibility requirements for delegates (including cross-border delegation) are needed. - Variations: - Restricted MIS: legacy schemes not requiring a MIS manager or Supervisor; must be constituted as a trust with trustee eligibility requirements. - KiwiSaver schemes: additional requirements including fees must not be unreasonable and investments must be readily transferable. - Wholesale MIS: offers only to wholesale investors are outside Registered MIS regime and not subject to FMA supervision; subject to Fair Dealing Obligations. ### Valuation of assets and Money Market Funds (MMFs) - Valuation frequency and methodology: - No specific regulatory requirement for frequency of publication of subscription or redemption prices for Registered MIS; FMA expects timing appropriate to MIS structure and SIPO. - For Managed Funds, MIS manager must calculate and disclose NAV of each fund at least quarterly in the Quarterly Fund Update; many funds calculate and disclose NAV daily. - MIS managers must have documented methodologies to value each type of asset, apply methodologies consistently, ensure valuations are made by personnel with appropriate skills, and address conflicts of interest. - Asset valuation must be independent of the investment management function. - Governing documents must detail methodology and rules for asset valuation and pricing of units. - Where an asset type is not covered by a specific valuation methodology, it is to be valued according to New Zealand GAAP (equivalent to IFRS). - No prescribed requirement to use forward pricing, but MIS managers are expected to do so in compliance with Overarching Duties. - Licensing minimum standards require policies and processes to prevent arbitrage; FMA is not aware of any MIS manager using historic NAV. - External valuers: permitted; MIS manager retains ultimate responsibility and must monitor external valuer performance. - MMFs: - No specific regulatory provisions or definition for Money Market Funds. - Very limited number of MIS invested in debt securities seeking daily liquidity and aiming to maintain constant NAV. - Market practice would include additional liquidity safeguards (longer notice periods, ability to limit or delay redemptions). - Role of Supervisors and auditors: - Supervisors must review and be satisfied valuation policies are appropriate and correctly applied; can engage valuation experts. - Auditors assess valuation as part of MIS annual accounts; financial statements must follow New Zealand GAAP. - Pricing errors: - FMC Act requires correction of material pricing errors, notification to Supervisor, reimbursement or compensation of disadvantaged investors. - No regulatory definition of materiality; each MIS manager must have explicit materiality policy. - Supervisors must report material pricing errors and remedial plan to the FMA. - Since implementation of notification regime, every reported MIS pricing error has been fully reimbursed by either the MIS manager or the administration manager. - Recommendation: - FMA may develop a framework for minimum valuation methodology requirements and discourage historic NAV and constant NAV practices in line with IOSCO guidance. - Money Market Funds should be defined through regulation. ### Liquidity risk, redemption risk and use of liquidity tools - Liquidity risk management expectations: - MIS managers must consider liquidity risk of underlying investments when forming investment strategy and have adequate processes to select and allocate assets consistent with the SIPO. - MIS managers are expected to stress test investment strategies appropriate to scheme assets. - As part of licensing, FMA assesses implementation, monitoring and review of liquidity risk management functions. - Liquidity management tools available if incorporated in governing document: - redemption notices, lock-in periods, liquidity buffers, gates, suspension of redemptions, redemptions in kind, side pockets, separate liquidity facilities, swing pricing, etc. - Changes introducing/removing tools typically require scheme participant approval or Supervisor approval if no material adverse effect. - Suspension/deferral: - MIS can suspend or defer redemptions if provided for in governing document. - If not included, manager can seek change to governing document or apply to court for power to suspend; FMA can direct suspension if necessary. - FMA sample findings: - Most MIS managers incorporate ability to suspend redemptions. - Side pockets and notice periods seen less often; swing pricing rarely used. - Regime is lightly prescribed but flexible; prescribed disclosure signals risks to investors. - Use of leverage: - No regulatory restrictions or limits on use of leverage by a Registered MIS. - Permitted where provided for in governing document and SIPO, disclosed to investors, and undertaken in accordance with Overarching Duties. - Self-imposed limits tend to be conservative (generally up to 20 percent of the NAV). - MIS managers must report derivatives positions every six months as part of portfolio composition reporting. - FMA perceives actual use of derivatives is very limited and leverage usage appears minimal, but available data is limited. - Recommendation: FMA should assess holdings data and Supervisors’ reviews to better monitor any significant increase in leverage. ### Safekeeping, segregation of assets and custodial arrangements - FMC Act requirements: - Assets of MIS must be segregated from those of the MIS manager. - Property of a Registered MIS must be held by the Supervisor, who can delegate custody to an external custodian if permitted by the governing document. - Assets must be held separate from Supervisor or custodian assets and are protected from insolvency of those entities. - Supervisor remains jointly liable for custody function where contracted out. - External custodians: - Not required to be licensed and not subject to prudential requirements. - Eligibility determined by Supervisor belief that firm is appropriate and functionally independent of the MIS manager. - Some custodians are subsidiaries of Supervisors and use omnibus accounts; detailed investor holdings kept by MIS manager or fund administrator. - FMA oversight limitations: - FMA has no direct oversight of custodian activities; insight is indirect through Supervisor monitoring. - Custodians are not prudentially supervised by any other New Zealand authority. - Recommendation: consider reviewing regulatory perimeter to require licensing and supervision of custodians, consistent with IOSCO Standards for the Custody of CIS’ assets. ### Authorization, licensing process and supervisory organization - Licensing and authorization: - FMA has a structured, documented licensing process using a risk estimate model (REMs) with qualitative and quantitative inputs to assign a risk estimate determining assessment intensity. - Review methods include desk-based reviews, requests for information, interviews, on-site reviews and engagement with Supervisors. - Core licensing team works with supervision team; supervision staff involved in licensing. - Throughout transition, FMA licensed 66 MIS managers. - MIS manager licensing standards and ongoing conditions: - Applicants must meet Eligibility Criteria under the FMC Act and Regulations. - FMA published a Licensing Application Guide covering legal requirements, fit and proper, capability, operational infrastructure, financial resources and governance. - FMA can impose additional license conditions and requires ongoing compliance with eligibility criteria. - Outsourcing reviewed at licensing; managers must report material outsourcing changes to FMA. - Supervisors licensing: - FMA assesses fit and properness, capacity, resources, controls, governance, independence. - Licensing regime for Supervisors in place for five years with progressive improvement through engagement. - Pre-lodgement review and governance review: - FMA has undertaken and "will continue" pre-lodgment review of MIS offer documents; sample review of governing documents and SIPOs provided "very relevant information". - Recommendation: FMA should consider reviewing SIPOs and governing documents for new MIS, focusing on systemic risk implications while Supervisors focus on unit holders’ protection. ### Supervision — approach, resourcing, reporting and enforcement - Supervision resources: - Supervision team staffing: 24.9 full-time employees (FTEs) responsible for ongoing monitoring of all entities under the FMA, including MIS managers, Supervisors and LITs. - Strategy and Risk team: 4.8 FTEs drafting monthly Emerging Risk Report. - Supervisory approach: - Risk-based supervision guided by Strategic Risk Outlook and bottom-up inputs (licensing, reporting, complaints, thematic reviews). - REMs being refined; REMs for MIS managers (post licensing) are being finalized. - Four supervisory activity types: monitoring by Supervisors, periodic monitoring and inspections, thematic reviews (target at least five per year), and reactive monitoring. - Supervisory strategic priorities: newly licensed MIS managers, follow-up monitoring of high risk managers, and monitoring of short-dated/licensing conditions. - Reporting regime: - Majority of reporting obligations are to Supervisors (SIPO changes, pricing errors, serious financial problems, related party transactions); significant events may trigger reports to FMA. - For Managed Funds: quarterly fund updates required (risk profile, portfolio composition at quarter end, target investment mix, top 10 investments and relativity to NAV). - Supervisors can require additional (monthly) reporting from managers and custodians. - Limit breaks: must be reported to Supervisor; uncorrected limit breaks within five working days must be reported; quarterly reporting on material limit breaks required. - Supervisors must deliver operational reports to FMA at least every six months and certify financial resources, independence and professional indemnity insurance. - FMA developing a regulatory return tool and mapping information flows; expects to finalize mapping "in the following months" and submit draft returns for industry consultation. - Recommendation: consider existing Supervisor reports to avoid duplication when developing regulatory returns. - Enforcement and investigations: - FMA powers include obtaining information, search and seizure, intelligence sharing, stop orders, direction orders, remedies, and civil and criminal proceedings. - Historical enforcement: since 2011 the FMA brought proceedings in relation to 19 finance companies, resulting in more than $82 million returned to investors, $18 million imposed as fines, 37 directors convicted and banned and 11 people agreeing to be subject to certain restrictions. - Enforcement applied proportionately; no meaningful information on sanctions or enforcement actions affecting MIS managers available due to novelty of MIS regime. ### Systemic risk monitoring and perimeter review - Strategic and operational monitoring: - Strategic Risk Committee (SRC) of senior staff meets monthly to discuss emerging risks; strategic risks recorded in a Risk Register and assessed against FMA framework. - Emerging Risk Report prepared monthly to identify growing or new risks. - Interagency cooperation: - Council of Financial Regulators (COFR): RBNZ, the FMA, the Treasury and MBIE meet quarterly; chair rotates between RBNZ and the FMA. - Trans-Tasman Emerging Risks Committee and Trans-Tasman Council on Banking Supervision for cross-border coordination. - Perimeter and wholesale market work: - FMA regularly reviews regulatory perimeter as part of systemic risk monitoring. - FMA developing a scoping study on wholesale markets to define role, clarify expectations around wholesale market conduct and access to data on market composition and trends. - Recommendation: promote scoping work on composition and size of wholesale asset management sector; aim to obtain reliable data to assess sector size and consider expanding regulatory perimeter if needed. *Source: IMF Technical Note, "EXECUTIVE SUMMARY", cr17117 (information current as of December 2016).* ### EXECUTIVE SUMMARY ___________________________________________________________________________ 4 ### cr17117 - EXECUTIVE SUMMARY ### Executive Summary: key findings and policy recommendations - New Zealand’s capital market regulatory framework underwent a major overhaul since the last FSAP in 2004; many capital market players (including asset managers) were not licensed or supervised at that time. - The Financial Markets Authority (FMA) was established as the conduct regulator of the financial sector and a licensing regime for managers of Managed Investment Schemes (MIS) is now in place. - Retail offers of MIS are regulated and subject to governance, disclosure and eligibility requirements. - Supervision of the asset management industry has recently started and is still developing: - The FMA completed initial licensing of MIS managers under the new regulatory regime in December 2016 and is in the process of refining a risk-based supervisory approach. - The licensing process provided the FMA with sector insight to identify major risks for ongoing supervision. - Financial Markets Supervisors (private licensed entities) are now required for retail MIS and are expected to perform statutory supervisory activities, including monitoring valuation policies, custody, leverage and liquidity risk management. - Regulatory gaps and concerns: - Custody services are not required to be licensed in New Zealand; custodians are outside direct FMA supervision and are not subject to prudential requirements or ongoing supervision by any other authority. - Wholesale asset management activities fall outside the FMC Act perimeter because the regime is centered on funds offered publicly to retail investors. Limited data on the wholesale sector hinders assessment of related risks. - Recommendations on supervisory approach: - The FMA should define its supervisory approach to asset management, giving significant consideration to the expectations placed on Supervisors and the risks of relying on them. - The FMA should ensure it retains direct oversight of areas relevant to sector stability and requiring technical or macro perspectives. - Monitoring of Supervisors should ensure consistent, high-quality supervisory work aligned with FMA priorities. - The FMA is engaged in systemic risk monitoring related to securities markets and asset management: - Strategic Risk Committee work to determine key strategic risks. - Participation in domestic and international cooperation forums, including the Council of Financial Regulators and the Trans-Tasman Emerging Risk Committee. - The FMA is undertaking a study on New Zealand’s wholesale markets to define its regulatory and supervisory role in wholesale asset management. ### Table 1: Main Recommendations on Regulation and Supervision of Managed Investment Schemes (as presented) - Develop a framework for minimum requirements for valuation methodologies and pricing practices, including restricting the use of historic net asset value (NAV) and constant NAV. — Priority: Short-Term - Define Money Market Funds within regulation of MIS. — Priority: Short-Term - Ensure that MIS’ use of leverage is monitored to be able to determine its actual size and growth. — Priority: Short-Term - Require that the provision of custody services be subject to licensing and supervision. — Priority: Short-Term - Continue the pre-lodgment review of MIS offer documents and introduce the review of SIPOs and governing documents of MIS at the time of registration. — Priority: Immediate - Ensure that the supervisory approach to MIS managers places an emphasis on direct monitoring by the FMA (as opposed to exclusively through Financial Markets Supervisors) of aspects most relevant to financial stability. — Priority: Immediate - Continue to engage with Supervisors to ensure that they take a consistent approach to their supervision of MIS managers and that this is aligned with FMA priorities. — Priority: Immediate - Ensure an appropriate supervision of delegated functions and consider whether more stringent requirements for eligibility of delegates (including for cross- border delegation) are needed going forward. — Priority: Immediate - Continue to refine the coverage and format of data reporting in the MIS sector to ensure appropriate monitoring of the risks and an efficient analysis of the information. — Priority: Immediate - Consider the need to expand the perimeter of regulation to ensure an appropriate oversight of the wholesale asset management sector. — Priority: Short-Term - Note: Immediate = Within one year; Short term = 1–3 years. ### Introduction: scope and benchmarks - The Technical Note reviews regulation, supervision and systemic risk monitoring of collective investment schemes (CIS), referred to in New Zealand as managed investment schemes (MIS). - Benchmarks: relevant International Organization of Securities Commissions (IOSCO) Principles and Standards (listed IOSCO documents used in the work are noted in the source). - Emphasis on areas most relevant to financial stability: valuation, segregation and safekeeping of fund assets, and redemption of fund units. - The note also reviews FMA application of the regulatory framework, supervision and systemic risk analysis. - On-site work was conducted during November 2016; information is current as of December 2016. ### Background: previous regime, reform, and current model - Previous regime (pre-reform): - The framework was light-handed in 2004; many participants were not subject to eligibility, governance or conduct requirements; regulation focused on disclosure. - Main laws then: Securities Act 1978 and Securities Markets Act 1988; other related legislation included the Financial Reporting Act, Companies Act, Reserve Bank of New Zealand Act, Unit Trust Act and Superannuation Schemes Act. - Heavy reliance on self-regulatory organizations and independent trustees, but the regime provided little substantive regulation or supervision of those entities. - Regulatory responsibilities were divided among multiple agencies (Securities Commission, Registrar of Companies, National Enforcement Unit, Government Actuary, Insurance and Superannuation Unit, Commerce Commission, Takeovers Panel). - The 2004 FSAP identified material deficiencies related to regulator capacity, CIS and market intermediaries, and recommended a common regulatory framework with minimum standards and ongoing oversight. - Regulatory reform timeline and measures: - Reforms approved in 2006 expanded enforcement powers of the Securities Commission and introduced new insider trading, market manipulation and adviser/broker disclosure rules. - KiwiSaver Act 2006 introduced a voluntary national work-based retirement savings initiative; KiwiSaver schemes now have over $37 billion in assets. - KiwiSaver schemes: managed by private KiwiSaver providers; special rules to encourage participation and retirement savings purpose; members choose providers or are allocated to one of nine government appointed Default Providers if they do not choose. - Early withdrawals permitted in limited circumstances. - Additional legislative reforms: - Financial Services Providers Act 2008 - Securities (Disclosure) Amendment Act 2009 - Securities Trustees and Statutory Supervisors Act 2011 (renamed Financial Markets Supervisors Act 2011) - Financial Markets Authority Act 2011 (FMA Act) - Review and replacement of Securities Act 1978 and Securities Markets Act 1988 leading to Financial Markets Conduct Act 2013 (FMC Act) and Financial Markets Conduct Regulations 2014 (FMC Regulations) - Most regulated businesses and individuals had until 1 December 2016 to transition into the new regime; parts of the FMC Act have been in force since April 2014. - Current regulatory model: - New Zealand operates a “twin peaks” model: - FMA: conduct regulator for the financial sector, consolidating prior functions and responsible for licensing and supervision related to governance, capability, controls, systems and financial resources. - Reserve Bank of New Zealand (RBNZ): prudential supervision of banks, insurers and nonbank deposit takers. ### Supervision and systemic risk monitoring priorities (analysis) - The supervisory regime is evolving; the FMA is refining a risk-based approach informed by initial licensing insights. - The reliance on private Financial Markets Supervisors to perform primary oversight of key MIS functions presents both benefits and challenges: - Benefit: leverages private supervisors for monitoring operational compliance. - Challenge: requires active FMA oversight to ensure consistency, alignment with FMA priorities and coverage of areas relevant to financial stability. - Custody services and delegates: - Current lack of licensing and supervision of custodians represents a gap given their role in safeguarding investor assets; recommendation is to require licensing and supervision of custody providers. - Delegation of functions requires appropriate supervision; consideration should be given to eligibility requirements for delegates, including cross-border delegation. - Data and coverage: - Continue refinement of MIS data reporting coverage and format to support risk monitoring and efficient analysis. - The FMA’s wholesale markets study is important to define its role and the perimeter of regulation for wholesale asset management. *Source: IMF Technical Note, "EXECUTIVE SUMMARY", cr17117 (information current as of December 2016).* ### 15. The FMA’s main objective is to promote and facilitate the development of fair, ### 15. The FMA’s main objective is to promote and facilitate the development of fair, ### FMA mandate, governance, funding, and strategic priorities - Main objective: promote and facilitate the development of fair, efficient and transparent financial markets. - Established: 2011 as an independent Crown entity not required to have regard to government policy. - Governance: governed by a Board; members appointed by the Governor-General on recommendation of the FMA’s responsible Minister. - Funding: mix of industry levies and government contribution. - Notable funding change: the FMA’s responsible Minister announced on November 3, 2016 the government’s approval to a funding increase for the FMA of approximately 20 percent of its budget, to come from changes in levies of financial services providers. The funding increase was considered necessary to account for the growth in the FMA’s responsibilities created by the implementation of the FMC Act and the progressive implementation of the Financial Advisers Act and the AML/CFT Act. - Strategic Risk Outlook: seven strategic priorities intended to focus resources on conduct that poses the most significant risk to the FMA’s objective: - (i) governance and culture; - (ii) conflicted conduct; - (iii) capital market growth and integrity; - (iv) sales and advice; - (v) investor decision making; - (vi) effective frontline regulators; - (vii) FMA effectiveness and efficiency. - Management responsibility: ensure priorities permeate the organization and guide disclosure, licensing, supervision and enforcement decisions. ### Regulatory and enforcement powers and tools - Legal basis: powers derived from the FMC Act and the FMA Act. - Enforcement and supervisory powers include: - information gathering and search and seizure powers; - ability to make stop orders and direction orders; - ability to seek relief and injunctions from the courts; - ability to bring civil and criminal actions. - Additional statutory powers: - power under the Financial Service Providers (Registration and Dispute Resolution) Act 2008 to deregister financial service providers; - ability to grant exemptions from the ordinary operation of the FMC Act and to designate products into appropriate categories (thereby calibrating the scope of the FMC Act); - ability to prescribe more detailed requirements through specification of frameworks or methodologies. ### FMC Act: Regulated Offers Regime — structure and key requirements - Regulated Offer concept: - An offer of financial products requires prescribed disclosure to be made to all investors who have received an offer, except offers detailed in Schedule 1 of the FMC Act (Schedule 1 Exclusions). - Where at least one investor able to accept the offer is not covered by Schedule 1 Exclusions, the offer is a Regulated Offer and triggers the Regulated Offer Regime. - Schedule 1 Exclusions: cover buy-side exclusions (e.g., offers to wholesale investors), sell-side exclusions (e.g., offers by the Crown or offers of debt by registered banks), and relationship-based exclusions (e.g., close business associates and relatives). - Primary elements of the Regulated Offer Regime: - Disclosure: - Requirement: all investors not covered by a Schedule 1 Exclusion must be provided with a Product Disclosure Statement (PDS). - PDS purpose: contain relevant information for a “prudent but not expert” investor to make an informed decision. - Each PDS must include a Key Information Summary (KIS) containing the issuer’s assessment of the most significant aspects of the offer relevant to investors. - Issuer must prepare a Register Entry containing all material information not in the PDS; it must be lodged on the Disclose Register. - Governance: - Offers of debt: must have a trust deed and a Supervisor before they can be made. - Offers of MIS: require a governing document, a manager, a Statement of Investment Policy and Objectives (SIPO) and a Supervisor. - Eligibility: - Activities associated with Regulated Offers that must be licensed: managers of certain MIS, Supervisors and derivatives issuers. ### Financial Markets Supervisors (Supervisors) - Regulated under the Financial Markets Supervisors Act 2011. - Main function: protect investors’ interests and act on their behalf in respect of the relevant MIS manager or debt issuer. - Key supervisory duties: - supervise issuer/manager performance in relation to legal obligations and financial position; - monitor that investments are made in accordance with the PDS, SIPO and governing document. - Powers to fulfill functions: - require managers or issuers to provide information; - engage experts; - approve auditors of the scheme or issuer; - in certain cases, appoint a receiver to the scheme and request winding up. - Reporting: receive regular reporting from MIS managers and debt issuers. ### Types of financial products and broader FMC Act conduct framework - Four product types under the FMC Act: equity securities, debt securities, Managed Investment Products (MIPs — which are MIS units), and derivatives. - Each product type has its own Regulated Offers Regime with tailored disclosure, governance and eligibility requirements. - Wider conduct regulation under the FMC Act: - Fair Dealing Obligations provide minimum compliance standards by prohibiting misleading or deceptive conduct, false or misleading representations, unsubstantiated representations and offers in unsolicited meetings; these obligations apply to all recipients of financial products or services (retail and wholesale). - Regime for regulating market abuse and breaches of continuous disclosure obligations. - Licensing regime for entities other than those involved in Regulated Offers (e.g., market operators, peer-to-peer lending and crowd funding platform operators, providers of discretionary investment management services). - Prescribes requirements relating to financial reporting, auditors, and marketing and distribution of financial products. - Financial advice is regulated by the Financial Advisers Act, overseen by the FMA. ### Registers: Disclose Register and Financial Service Providers Register (FSPR) - Disclose Register: online register for offers of financial products and MIS under the FMC Act; at the end of the transition period it will replace some Companies Office and FMA registers. - Financial Service Providers Register (FSPR): searchable online register of people, businesses and organizations that offer financial services in New Zealand. - Registration as a financial service provider is not an official approval and does not necessarily indicate licensing or regulation in New Zealand or any other country. - A reform of the FSPR is currently under discussion to re-design features so registration does not create a misleading appearance as to regulation by New Zealand law. - Administration: both Registers are under the control of the Companies Office (part of MBIE); the FMA receives immediate notification of updates or changes related to any firm or product under its supervision and of new entries. - Coordination: the FMA and the Companies Office meet regularly to discuss coordination issues. ### Regulation and supervision of Managed Investment Schemes (MIS) — market structure and AUM - KiwiSaver impact: - KiwiSaver schemes are MIS managed by KiwiSaver providers (licensed MIS managers under the FMC Act). - As at September 30, 2016, there were 2.67 million New Zealanders who were members of KiwiSaver with funds invested in 30 KiwiSaver schemes of about $37.7 billion. - KiwiSaver funds have become New Zealand’s most important MIS product. - Other MIS AUM (as at September 30, 2016 unless otherwise noted): - licensed MIS managers manage approximately $32.6 billion invested in retail unit trusts; - about $22.5 billion invested in other registered superannuation schemes; - about $9.2 billion in cash management trusts (money market products). - Market concentration: - At December 1, 2016, there were 377 Registered MIS and 66 licensed MIS managers. - Total AUM of MIS managers were approximately $129 billion (as at September 30, 2016). - About 50 percent of assets invested in MIS are managed by the top three New Zealand MIS managers. - The top ten MIS managers manage about eighty percent of assets invested in New Zealand MIS. - Foreign MIS: - Foreign MIS can be offered under mutual recognition regimes. - Current mutual recognition with Australia allows offers of MIS by Australian managers to New Zealand investors provided compliance with Australian law; there are currently 480 Australian MIS offers open through this regime. - New Zealand, Australia, Japan, Korea and Thailand are developing a partial mutual recognition regime called the “Asia Region Funds Passport.” - Umbrella schemes and outsourcing: - Some MIS are umbrella schemes with multiple funds; each fund meets the definition of MIS but is not registered independently. - MIS managers may invest in third-party managed funds; those third-party investment managers do not necessarily need to be licensed in New Zealand. - Data limitations: - Wholesale funds and wholesale fund managers are not supervised by the FMA; therefore no official data are available on the size of the wholesale sector. - Wholesale MIS are not required to register; the FMA does not currently have data on the number of wholesale MIS in New Zealand. ### MIS definitions, typology, and registration categories - MIS definition (economic substance test): a scheme is a MIS where: - (i) the purpose is to enable participants to contribute money to acquire interests in the scheme; - (ii) those interests are rights to participate in, or receive, financial benefits produced principally by the efforts of another person under the scheme; - (iii) holders of those interests do not have day-to-day control over the operation of the scheme. - Legal structures permitted: trusts, limited or special partnerships, syndicates, or contractual participation; existing MIS most commonly take the form of unit trusts. - MIS typology based on public offering/registration: - Registered MIS: where there is a Regulated Offer of interests or the MIS is voluntarily registered; subject to the standard Regulated Offer Regime for MIS. - Restricted MIS: alternative governance framework for certain legacy schemes with restricted membership; no Restricted MIS can be created after December 1, 2016. - Wholesale MIS: units not offered publicly under the Regulated Offers regime; exempt from the FMC Act MIS framework but subject to fair dealing requirements for marketing/distribution; may voluntarily register. - Disclosure distinction for Registered MIS: - Managed Funds: Registered MIS that are open-ended or invest at least 80 per cent of assets in certain eligible securities deemed liquid; includes KiwiSaver schemes, superannuation schemes, workplace savings schemes. - Other MIS: Registered MIS not qualifying as Managed Funds; typically invest in more illiquid assets like forestry or real estate. ### Quantified tables and sector statistics (as provided) - KiwiSaver AUM by asset class (September 30, 2016; Data for AUM of the 25 KiwiSaver schemes that are Registered MIS. Excludes the 5 Restricted KiwiSaver schemes with AUM of $675 million): - Australasian equities: $4,904.20 M — 13.24 percent of assets - Cash: $7,352.31 M — 19.86 percent of assets - International equities: $9,703.62 M — 26.20 percent of assets - International fixed income: $7,207.64 M — 19.46 percent of assets - Listed property: $1,688.38 M — 4.56 percent of assets - NZ Fixed interest: $5,489.89 M — 14.83 percent of assets - Other: $494.47 M — 1.34 percent of assets - Unknown: $0 — 0 percent of assets - Unlisted property: $189.16 M — 0.51 percent of assets - Total: $37,029.67 M — 100 percent of assets - Source: FMA. - Assets under Management by New Zealand MIS Managers (Number of MIS as of December 2016; AUM as of September 30, 2016): - Registered MIS: 377 — AUM $88,115 M - Wholesale MIS: No complete data — AUM $27,222 M - Restricted MIS: 109 — AUM $13,868 M - Total: 486 — AUM $129,205 M - Note: Wholesale MIS are not required to register and the FMA does not currently have data on the number of wholesale MIS in New Zealand. The wholesale AUM figure is taken from the RBNZ Managed Fund Survey and may include some funds managed on behalf of Registered MIS. ### Core compliance requirements for Registered MIS - Eligibility and operational conduct: - MIS managers of Registered MIS must be licensed by the FMA under the FMC Act and satisfy minimum eligibility conditions. - MIS managers must comply with Overarching Duties of Managers: act honestly; act in the best interest of scheme participants; treat participants equitably when exercising powers or duties; not make use of information acquired through its role to gain an improper advantage or cause detriment to participants. - MIS managers must comply with Licensee Obligations set out by the FMC Act, license terms, the governing document and, where applicable, the KiwiSaver Act. - A Registered MIS must engage a Supervisor. - Governance: - Governing document must set out rules of the MIS in compliance with the FMC Act and cover at least: transferability of MIPs, subscription and redemption of MIPs, methodology for calculation of NAV and unit price, fees, appointment and removal of Supervisor and MIS manager, and winding up of the scheme. - Statement of Investment Policies and Objectives (SIPO): - Foundation for investment governance; provides accountability and disclosure. - Required to be made publicly available. - FMA expectations: SIPOs should describe investment strategy and objectives in terms of performance and risk and the parameters for monitoring performance and policies directly relevant to achieving investment objectives (e.g., hedging, tactical asset allocations, liquidity and cash flow management, leverage and diversification requirements). - Supervisor monitors compliance against the SIPO and must be given prior notice of any SIPO changes. - Changes to the governing document must be approved by scheme participants or, in some instances, by the Supervisor if satisfied that the amendment does not have a material adverse effect on participants and appropriate disclosure is made. - Custody: - Scheme property must be held independently of the MIS, either by the Supervisor or by an external custodian. - Disclosure: - Before making a Regulated Offer of a Registered MIS the manager must prepare a PDS, with contents heavily prescribed and differing depending on whether the MIS qualifies as a Managed Fund or as Other MIS. *Source: cr17117 - 15. The FMA’s main objective is to promote and facilitate the development of fair, (PDF chapter).* ### 30. MIS managers are permitted to delegate some or all of their functions while retaining ### cr17117 - 30. MIS managers are permitted to delegate some or all of their functions while retaining ### Delegation and outsourcing of MIS manager functions - MIS managers are permitted to delegate some or all of their functions while retaining liability for the performance of those functions. - When outsourcing management functions, the MIS manager must take all reasonable steps to ensure that those functions are performed in the same manner and subject to the same duties and restrictions, as if the MIS manager were performing them directly. - The manager is expected to monitor the performance of delegated functions. - Delegated functions will be disclosed as part of the PDS information. - Where there are changes in the delegation of functions, the MIS manager will need to make prescribed disclosures in the Quarterly Fund Update and/or annual report and consider the ongoing compliance of their PDS with the requirements of the FMC Act. ### Eligibility of delegated entities and supervisory emphasis - Regulatory requirements on the eligibility of delegated entities are fairly light; the regime focuses on managers’ oversight of the performance of delegated functions. - The requirement that the manager must ensure delegated functions are performed in accordance with the FMC Act regime should ensure certain implicit eligibility standards for the delegated entity. - MIS managers remain responsible for meeting the eligibility criteria and minimum standards for any outsourced function, which should prevent managers from being mere letterbox entities. - Any risks from this light approach should be contained through ensuring appropriate supervision of delegated functions. - The FMA should consider whether more stringent requirements for eligibility of delegates (including any requirements for cross-border delegation) are needed. ### Variations: Restricted MIS and KiwiSaver schemes - Restricted MIS: - Are legacy schemes from before the FMC Act. - Were superannuation schemes and workplace savings schemes allowed to continue under a variation of standard Registered MIS requirements. - Must comply with standard FMC Act requirements for a governing document and SIPO, but Restricted MIS are not required to have a MIS manager or a Supervisor. - Must be constituted as a trust and be managed by the trustees, of which at least one must be either (i) a Licensed Independent Trustee (LIT) or (ii) a sole corporate trustee, with at least one director who is a LIT. - Scheme property must be held independently of the MIS by a corporate body that is either the corporate trustee or has as its directors only persons who are trustees, or an external custodian authorized by the governing document. - Are subject to more flexible operational conduct requirements and the license conditions for LITs are less prescriptive. - Given the relatively small size of Restricted MIS’ assets compared to the MIS universe and that no more entities will be created under this regime, a less stringent regime is considered reasonable, potentially supplemented by an intense supervisory approach. - KiwiSaver schemes: - Have additional requirements: fees must not be unreasonable and investment in a KiwiSaver scheme must be readily transferable. ### Wholesale MIS - Offers of MIS made only to wholesale investors are not subject to the Registered MIS regime. - These schemes do not have to comply with requirements for eligibility, governance, custody and disclosure and are not subject to reporting to or supervision from the FMA. - Investment managers and distributors of Wholesale MIS are subject to the Fair Dealing Obligations of the FMC Act and therefore subject to prohibitions on misleading conduct, false or misleading representations and making unsolicited offers. ### MIS Supervisors (summary of Box 2) - Under the FMC Act, a Regulated Offer of MIS must have a Supervisor licensed by the FMA. As of November 2016 there were 5 Supervisors in New Zealand that were licensed in respect of Registered MIS. - Fundamental functions of Supervisors: - Act on behalf of scheme participants in relation to the MIS manager. - Act in relation to matters connected with the governing documents or the terms of any Regulated Offer. - Act in relation to any breaches of Issuer Obligations under the FMC Act. - Supervise the MIS managers’ performance of its functions and Issuer Obligations, the financial position of the MIS manager and the schemes it manages. - Supervisors’ duties and powers: - General duties to act honestly and in the best interest of participants and meet professional standards of care; exercise the care, due diligence and skill that a prudent person engaged in the business of acting as a licensed Supervisor would exercise. - Expected to determine systems and processes needed to meet duties in relation to each MIS manager that engages them. - Process for replacing a Supervisor primarily determined by the governing document; Supervisor can also be removed by a special resolution, High Court decision, or decision of the FMA in accordance with the Financial Markets Supervisors Act. - Responsible for primary oversight of significant features of MIS framework, including reviewing and monitoring asset valuation policies, ensuring implementation of investment strategy in accordance with the SIPO (monitoring leverage, compliance with investment limits, use of liquidity risk management policies), and ensuring accurate disclosure. - Can require MIS managers to provide any information at any point in time, engage experts, call meetings of scheme participants, or apply to court for directions. - Will receive regular reporting from MIS managers and external custodians; are primary responsible entities for holding MIS property on behalf of scheme participants. - If custody is contracted out, the Supervisor must appoint and monitor the external custodian. - Aside from custody of scheme property, the Supervisor cannot delegate any of its functions. - The FMA has a duty to monitor the conduct of Supervisors and their ability to meet statutory functions; FMA receives regular reports from Supervisors describing interactions with their appointments and summary of how issues were resolved. ### Focus of subsequent discussion (financial stability relevance) - The discussion focuses on elements of the regulatory framework most relevant for financial stability and points out areas where the regulatory framework is not compliant with relevant IOSCO Principles or Standards or where enhancements are recommended. - The manner in which the FMA addresses compliance when authorizing and supervising firms and funds and monitoring sector risks is discussed in sections C and D (beyond this excerpt). ### Valuation of assets - There is no specific regulatory requirement relating to the frequency of publication of subscription or redemption prices for Registered MIS. - The FMA considers appropriate timing for valuation depends on MIS structure, nature of assets and investment strategy as reflected in the SIPO. - For Managed Funds, the FMC Act requires that the MIS manager must calculate and disclose the NAV of each fund at least quarterly (in the Quarterly Fund Update lodged with the Disclose Register). In practice, many of these funds calculate and disclose their NAV on a daily basis. - MIS managers must ensure valuations are made in accordance with the relevant valuation methodology specified in the governing document. - MIS managers must: - Have documented methodologies to value each type of asset. - Apply methodologies consistently across similar asset classes and review them periodically. - Ensure assets are valued regularly and independently by staff with the right skills. - Address any conflict of interest. - MIS manager minimum standards require the asset valuation function be carried out independently of the investment management function. - The methodology and rules for valuation of assets and pricing of units must be detailed in the governing document (accessible at the Disclose Register). - Where an asset type is not covered by a specific valuation methodology, it is to be valued according to New Zealand GAAP (which is equivalent to IFRS). - There is no prescribed requirement to use forward pricing, but MIS managers are expected to do this in compliance with their Overarching Duties as Managers. - Licensing minimum standards include a requirement that the MIS manager has policies and processes to prevent arbitrage; FMA is not aware of any MIS manager using historic NAV. - MIS managers are allowed to use an external valuer and many outsource this function; where engaged, the MIS must ensure the engagement is conducted in accordance with the FMC Act and minimum standards, must monitor performance of the external valuer, and retains ultimate responsibility. ### Money Market Funds (MMFs) and valuation - There are no specific regulatory provisions for the valuation of Money Market Funds (MMFs). - The regulatory regime does not provide for a definition of MMF or provisions on valuation of these types of funds. - There appears to be a very limited number of MIS invested in debt securities and seeking to provide daily liquidity that are offered with the aim of maintaining a constant NAV. - Market practice would be to provide additional liquidity safeguards for these funds like a relatively longer notice period for redemptions and the ability to set limits or delay redemptions in specific circumstances. ### Role of Supervisors and auditors in valuation - Supervisors have an obligation to review and be satisfied that a MIS asset valuation policy is appropriate and is being correctly applied; can engage a valuation expert. - Auditors review valuation of MIS assets as part of their review of MIS annual accounts. - MIS managers must prepare financial statements for any Registered MIS they manage and these must be audited by a qualified independent auditor. - Auditors must assess whether measurement and disclosures in relation to scheme’s assets are in accordance with applicable accounting standards. - Financial statements must be prepared in accordance with New Zealand GAAP; NZ GAAP involves using equivalents to International Financial Reporting Standards as issued by the International Accounting Standard’s Board for Registered MIS, Restricted MIS, and MIS managers. ### Treatment of pricing errors - The FMC Act provides guidance on reporting and correction of pricing errors and non-compliance with pricing methodologies. - Where a material pricing error or non-compliance with pricing methodologies occurs, MIS managers are required to correct the error, notify the Supervisor and ensure any disadvantaged investor is reimbursed or compensated appropriately. - There is no regulatory definition of materiality, but every MIS manager must have an explicit policy to determine when an error or non-compliance with pricing methodology is material. - In practice, thresholds of materiality set by managers seem reasonable for appropriate protection of unit holders. - Supervisors monitor and assess pricing errors. MIS managers must report material pricing errors to the Supervisor, who must have processes to identify and assess material notifications. - Under the FMC Act the Supervisor must report any material pricing error, along with details of a remedial plan, to the FMA. - Since implementation of this notification regime, every reported MIS pricing error has been fully reimbursed by either the MIS manager or the administration manager, depending on the cause of the error. ### Regulatory assessment and recommendations on valuation and MMFs - The FMC Act regime contains a comprehensive framework for valuation of assets of MIS and covers most relevant aspects of the IOSCO Principles and Standards relating to valuation of CIS assets. - The FMA may consider developing a framework for MIS managers and Supervisors on certain minimum requirements that valuation methodologies should encompass. - Such guidance could ensure that practices like historic NAV pricing and use of constant NAV are clearly discouraged, in line with Principle 9 of the IOSCO Principles for the Valuation of CIS Assets and Recommendation 10 of IOSCO Policy Recommendations for MMFs. - Money Market Funds should also be defined through regulation, in line with Recommendation 1 of the Policy Recommendations for MMFs. ### Management of redemption risk and liquidity risk management - The FMC Act does not have an explicit definition of liquidity but MIS managers are required to manage liquidity risk appropriately. - All MIS have flexibility to set their investment strategy, provided they meet governance and disclosure requirements of the FMC Act. - MIS managers are expected to have robust processes and controls to manage liquidity risks associated with the MIS investment strategy; these processes must be documented in the governing document of each MIS. - The FMC Act does not prescribe specific liquidity, diversification or concentration limits; MIS liquidity risk management policies should be detailed in the SIPO. - The SIPO should contain policies relevant to achieving investment objectives and strategies, including liquidity and cash flow management policies, tactical asset allocation policies, rebalancing, hedging and any diversification requirements or limits. - Monitoring compliance with SIPO prescriptions is one of Supervisors’ major duties with respect to MIS. *Source: cr17117 - 30. MIS managers are permitted to delegate some or all of their functions while retaining (excerpt).* ### 47. As part of the licensing process, the FMA assesses whether the liquidity risk ### As part of the licensing process, the FMA assesses whether the liquidity risk ### Liquidity risk management expectations - The FMA’s expectation is that, for a MIS manager to be capable of effectively managing the investments of the MIS, it has to consider the liquidity risk of the underlying investment products in forming the investment strategy. - MIS managers must have adequate and effective processes to select and allocate assets to comply with the SIPO and taking into account the liquidity for different types of assets and the impact of investment techniques and strategies. - MIS managers are expected to stress test their investment strategies as appropriate for the particular investment strategy or scheme assets. - As part of the licensing process, the FMA assesses whether the liquidity risk management functions of MIS managers are appropriately implemented, monitored and reviewed. ### Liquidity management tools and governing documents - A MIS manager can use any tool incorporated in the governing document of the MIS to manage the scheme’s liquidity, including redemption notices, lock-in periods, liquidity buffers, gates, suspension of redemptions, redemptions in kind, side pockets, separate liquidity facilities, swing pricing, etc., if these were incorporated into the governing document. - Changes to the governing document to introduce or remove liquidity management tools will typically require the approval of scheme participants or of the Supervisor, if it is satisfied that the amendment does not have a material adverse effect on the participants. ### Suspension and deferral of redemptions - A MIS can suspend or defer redemptions as long as this is provided for in its governing document. - In exercising their discretion to suspend or defer redemptions (for example in the occurrence of a liquidity event), MIS managers will need to comply with their Overarching Duties as Managers to act in compliance with a professional standard of care. - The Supervisor will monitor the MIS manager and MIS in these situations and report to the FMA the steps to be taken to address a liquidity event. - Exceptional power to suspend redemptions: - If suspension is not included in the governing document, MIS managers can either (i) seek a change to the governing document (a process that could be dealt with expediently by obtaining permission of the Supervisor if the change does not have a material adverse effect on participants) or (ii) apply to the court for an additional power to suspend redemptions, which the court will grant if it considers this to be in the best interest of participants. - The FMA would also be able to intervene and give a direction to suspend redemptions, when it considers that a MIS manager or Supervisor is not adequately managing a valuation, pricing or redemption matter not contemplated by the governing document. ### FMA review of liquidity tools (sample findings) - The FMA has done a high level sample review of liquidity risk management tools described in SIPOs and governing documents of MIS throughout the MIS manager licensing process.25 - Anecdotal evidence from licensing: - Most MIS managers incorporate the ability to suspend redemptions in the governing documents. - Other tools like side pockets and notice periods are seen less often. - Swing pricing appears to be rarely used. - Assessment: The liquidity risk management regime is lightly prescribed but flexible enough to permit use of any liquidity management tools appropriate to the MIS under management, including suspending redemptions. - Prescribed disclosure ensures that any risks are appropriately signaled to investors through the PDS. - Any limits or controls to the investment strategy of each MIS, and the ability of the MIS manager to use any exceptional liquidity management tools, are set out in the SIPO and governing document and therefore monitored by the Supervisor. - An adequate supervisory approach by the FMA should mitigate any potential risks arising from the lightly prescribed regime. ### Use of leverage - There are no regulatory restrictions or limits on the use of leverage by a Registered MIS. - Conditions for use of leverage: - (i) provided for in the governing document of the MIS and SIPO; - (ii) disclosed to investors in the PDS/Register Entry; - (iii) undertaken in accordance with the Overarching Duties of Managers to act in compliance with a professional standard of care. - The FMA considers it generally appropriate to provide limits on leverage usage where leverage is permitted; such limits would be established in the SIPO and governing document. - Supervisory monitoring: - Supervisors monitor the use of leverage by Registered MIS managers, ensuring compliance with governing documents and accurate disclosure to investors. - Supervisors receive regular reporting from managers and custodians and review these reports against the SIPO. - Supervisors undertake ongoing monitoring of the policies, processes and controls the MIS manager has in place to ensure compliance with the SIPO and that any leverage is appropriately disclosed to investors. - Perception and reporting: - There is a general perception that leverage is minimally used by New Zealand MIS managers, but available data is limited. - Many governing documents permit the possibility of using leverage through borrowing (short term only, to effect redemptions) or through the use of derivatives. - For those MIS that can use leverage, self-imposed limits tend to be very conservative (generally up to 20 percent of the NAV). - The FMA’s perception is that the actual use of derivatives by MIS managers is very limited (other than for hedging purposes) and limited to a few funds. - Under the FMC Act MIS managers must report their derivatives positions as part of their portfolio composition every six months, which will give the FMA an initial sense of the actual use of synthetic leverage by New Zealand Registered MIS. - Even without prescribed limits, the use of leverage by New Zealand MIS managers seems quite conservative. - The FMA should assess the data on holdings reported by MIS managers of Registered MIS and the Supervisors’ review of MIS’ use of leverage to better monitor any significant increase. ### Safekeeping and segregation of fund assets - FMC Act requirements: - Assets of MIS must be segregated from those of the MIS manager. - The property of a Registered MIS must be held by the Supervisor, who can delegate custody to an external custodian if permitted by the MIS governing document. - Assets must be held separate from the assets of the Supervisor or custodian and are protected from the insolvency of any of those entities. - When delegating custody services, the Supervisor must ensure the function is performed in the same manner as if the Supervisor was performing it directly and monitor such performance. - Where scheme property is contracted out to an external custodian, the Supervisor remains jointly liable for the performance of the custody function. - External custodians: - External custodians providing services in relation to MIS do not need to be licensed entities and are not subject to any prudential requirements. - To be eligible to be appointed as an external custodian of a Registered MIS, a firm must (i) be a legal entity that the Supervisor believes to be appropriate to hold and safeguard MIS assets and (ii) be functionally independent of the MIS manager. - In practice, a number of New Zealand custodians are subsidiaries of Supervisors and are permitted to use omnibus accounts to register assets of each fund on behalf of investors; detailed account of units held by each individual investor is kept by the MIS manager or the fund administrator. - FMA oversight limitations and consideration: - The FMA has no direct oversight of the activities of custodians; custody operations do not need to be separately licensed whether provided by a licensed Supervisor or an external custodian. - The FMA has some indirect insight through monitoring of Supervisors, including governance and culture and the Supervisor’s processes, approach and criteria when approving and monitoring custodians. - Given custodians perform key functions regarding safeguarding investors’ assets, consideration should be given to reviewing the perimeter of regulation to require them to be licensed. - Custodians are not prudentially supervised by any other authority in New Zealand. - IOSCO’s Standards for the Custody of CIS’ assets recognize that most regulatory regimes require CIS custodians to be licensed, authorized or approved and subject to ongoing regulatory oversight. ### Authorization and licensing process - The FMA has a structured and documented process to assess and verify license applications, including a risk evaluation to determine the level of assessment required. - Applicants are assessed through a risk estimate model using qualitative risk factors (e.g., complaints, alerts or warnings) and quantitative data to assign a risk estimate for the license application; the risk rating determines the intensity of assessment. - Depending on the risk level, review and assessment can entail desk-based reviews, requests for further information, interviews with the applicant, on-site reviews and/or engagement with the applicant’s Supervisor. - The FMA has a core licensing team which works with the broader supervision team; licensing team reviews applications for completeness and undertakes fit and proper checks before handing to the supervision team to assess eligibility criteria. - Staff in the supervision team are involved fully in the licensing process; staff are not necessarily assigned to specific types of applicants, enabling flexible leveraging of expertise. - Throughout the transition to the FMC Act regime, the FMA licensed 66 MIS managers. ### MIS manager licensing standards and ongoing conditions - Any person acting as the MIS manager of a Registered MIS must be licensed by the FMA. - To issue a license, the FMA must be satisfied that the MIS manager has met all relevant requirements in the FMC Act and Regulations (Eligibility Criteria). - The FMA has published a Licensing Application Guide setting out minimum standards for MIS managers covering legal requirements, fit and proper, capability, operational infrastructure, financial resources and governance. - The FMA expects applicants to explain how their approach is appropriate to meet minimum standards and Eligibility Criteria for the size and nature of their business. - The FMA can impose additional license conditions on a MIS manager; the licensee must continue to meet eligibility criteria on an ongoing basis and will be subject to standard license conditions. - The FMA may set additional specific conditions for individual managers on a case-by-case basis; some conditions are imposed on a transitional basis and will be reviewed as part of follow up monitoring. - Outsourcing: - MIS managers can outsource functions (e.g., investment management and/or administration) while remaining responsible for those functions; there is no separate requirement for the external provider to be licensed.26 - The FMA assesses delegation arrangements at licensing, verifying that the manager has appropriate processes to ensure the external provider is capable, legal arrangements for effective monitoring and records availability for inspection by the FMA, and a performance program to monitor the provider’s performance. - MIS managers are required to report any material changes to outsourcing arrangements to the FMA. ### Licensing assessment practices and sampling - To assess managers’ ability to perform functions at licensing, the FMA has done a high-level sample review of governing documents for some MIS. - Licensing staff reviewed a sample of SIPOs and governing documents for MIS managed by each manager, providing an overview of fund types offered and how manager resources and expertise match product complexity. - This sampling provided indication of whether manager processes are fit for purpose for offered investment strategies (e.g., liquidity risk management, use of leverage and valuation of assets). ### Role and assessment of Supervisors - To license a Supervisor, the FMA must be satisfied the applicant is capable of effectively performing its functions; assessment covers fit and properness, capacity, resources, controls and processes, governance, and independence. - Significant review focus: compliance monitoring and how the Supervisor will ensure MIS managers it oversees will comply with their obligations. - FMA examines the Supervisor’s independence from the MIS manager, including relationships of the Supervisor or its directors and senior managers that may compromise independence. - The licensing regime for Supervisors has been in place for five years, and the FMA’s regular engagement has resulted in progressive improvement of standards. ### MIS registration and offer document review - MIS are not subject to licensing, but are registered on the Disclose Register. - Before making a Regulated Offer, the MIS manager must register the MIS on the Disclose Register and prepare a PDS and supply the Registrar with required register entry information (such as governing documents and the SIPO). - While the Registrar assesses compliance with registration requirements, the FMA carries out pre and post lodgement reviews of offer documents; the pre-lodgement review process is not a legal requirement but aims to ensure offer documents are likely to meet FMA’s expectations. - Once an offer is lodged, the FMA rates it and reviews it in accordance with its risk estimate model; where potential non-compliance is found, the FMA will contact the MIS manager to resolve queries or have documents withdrawn or amended. - Review outcomes and engagement: - From the introduction of the FMC Act until 1 December 2016, the FMA has reviewed the PDS of 109 MIS that have registered on the Disclose Register. - The review process has provided valuable market information on industry approaches to and disclosure of risk. - FMA staff have met with MIS managers where needed to discuss content quality and approach to risk under the new regime, improving FMA understanding of MIS offered and assisting future supervision. ### Overall assessment - The FMA has comprehensive and well documented processes for the licensing of MIS managers and Supervisors and is appropriately resourced to carry out that function. - Licensing is considered a confirmation of compliance with minimum entry-level standards; the FMA aims to raise standards over time through supervisory/monitoring processes and industry engagement. *International Monetary Fund — cr17117 (excerpt)* ### 74. The FMA should continue the pre-lodgment review of MIS offer documents. The FMA ### cr17117 - 74. The FMA should continue the pre-lodgment review of MIS offer documents. The FMA ### Pre-lodgment review and governing documents - The FMA has undertaken and "will continue" the pre-lodgment review of MIS offer documents to ensure alignment with the FMC Act and to address issues before lodgment. - Sample review of governing documents and SIPOs for newly registered MIS has provided "very relevant information" to the FMA. - Recommendation: The FMA should consider reviewing SIPOs and governing documents for new MIS, taking a hands-on approach focused on systemic risk implications while Supervisors focus on unit holders’ protection. ### Supervision — organization and resources - Supervision team staffing: 24.9 full-time employees (FTEs) responsible for ongoing monitoring of all entities under the FMA, including MIS managers, Supervisors and LITs. - Supervision staff have been involved in licensing of MIS managers to gain better industry understanding. ### Supervisory approach - The FMA applies a risk-based approach to supervision, focusing on participants that pose the greatest risk to fair, efficient, and transparent financial markets. - Monitoring priorities are guided by top-down and bottom-up considerations: - Top-down: review of the Strategic Risk Outlook (SRO). - Bottom-up: information from licensing, monitoring, reporting, complaints, thematic reviews, and interaction with market participants, assisted by risk estimate models (REMs). - REMs inputs: quantitative data and qualitative assessments from reports, notifications, monitoring work and thematic reviews; risk factors are scored and weighted to produce consequence, likelihood and a final risk score. - Status: REMs are being refined; REMs for MIS managers (post licensing) are being finalized and expected to assist in determining future supervisory cycles. ### Scope of supervisory activities - Four broad supervisory areas for MIS: - Monitoring provided by Supervisors (frontline monitoring); FMA retains the ability to monitor the same MIS managers and has ongoing oversight of Supervisors via reporting, on-site visits and market trend assessment. - Periodic monitoring and inspections (on-site visits, desk-based reviews, telephone interviews), prioritized based on licensing process outputs. - Thematic reviews (data gathering, analytics, desk research, on-site activity) with a target to complete at least five thematic reviews per year; recent areas included sales and advice by financial service providers (including KiwiSaver providers) and corporate governance disclosure. - Reactive monitoring and inspections in response to market feedback, investor complaints, Supervisor reports or co-regulator referrals. ### Supervisory focus and priorities - Key oversight areas (noted as particularly relevant to financial stability): liquidity risk management (including stress testing, suspension of redemptions), valuation of MIS assets, segregation and custody of assets. - Under the FMC Act these are primarily monitored by Supervisors through oversight of compliance with the SIPO and governing documents, but the FMA retains supervisory capacity over all aspects of MIS management. - Supervisory strategic priorities for the next fiscal year will focus on newly licensed MIS managers, including follow-up monitoring of MIS managers identified as high risk and monitoring of short-dated/prerequisite conditions and additional specific licensing conditions. ### Enforcement and investigations - The FMA has a broad range of investigation and enforcement powers, including obtaining information, documents and evidence, entry and search under a court search warrant, intelligence sharing with domestic and foreign counterparts, remedies for breaches, imposition of remedies on supervised entities, stop orders, direction orders, warnings, and civil and criminal proceedings. - Investigations arise from multiple sources; the FMA is developing the Information and Contacts Management Framework to systematize collection, handling, analysis and response to information received across the FMA. - Historical enforcement context: legacy enforcement action (largely related to finance companies from the Global Financial Crisis) is "almost complete"; since 2011 the FMA brought proceedings in relation to 19 finance companies, resulting in more than $82 million returned to investors, $18 million imposed as fines, 37 directors convicted and banned and 11 people agreeing to be subject to certain restrictions on their ability to be involved in the management of entities. - The FMA has used the wider range of tools provided by the FMC Act; enforcement has been used proportionately to harm, alleged conduct and public interest factors. (No meaningful information on sanctions or enforcement actions affecting MIS managers was available for this mission due to the novelty of the MIS regime.) ### Supervisory recommendations and coordination with Supervisors - The FMA should retain direct monitoring of aspects most relevant to financial stability while leveraging Supervisors’ oversight. - The FMA should set clear expectations for Supervisors’ oversight and periodically review compliance with those expectations as Supervisors and the MIS industry mature. - The FMA should ensure appropriate oversight of Restricted MIS, reflecting their relatively less stringent regulatory framework. - The FMA should continue to engage with Supervisors to promote consistency in MIS supervision, aligning Supervisor monitoring with FMA priorities while allowing appropriateness to MIS managers’ business models. - Delegation and outsourcing: review of outsourcing should be an early monitoring theme; the FMA should assess extent of delegation, qualifications of delegated entities, and cross-border outsourcing of investment management functions for supervisory cooperation implications. ### Reporting regime - MIS managers reporting: - Majority of reporting obligations require reporting to the Supervisor (changes to SIPO, pricing errors, serious financial problems, related party transactions). - Significant changes (probability of insolvency event, auditor resignation) may trigger reports to the FMA. - For Managed Funds: quarterly fund updates including risk profile, actual portfolio composition at the end of the quarter, target investment mix and the top 10 investments and their relativity to the net asset value of the fund. - Supervisors can prescribe additional information (typically monthly reports) from MIS managers and custodians on portfolio composition, transactions, use of leverage, value of assets, etc. - Limit breaks: - Deviations from mandate must be reported to the Supervisor as a limit break. - Any limit break not corrected within five working days must be reported to the Supervisor. - MIS managers must provide the Supervisor with a quarterly report on all material limit breaks in the period. - Where a limit break reflects a material issue with operational conduct, it must be reported to the FMA. - The FMA can require additional information or more frequent reporting via license conditions. - Regulatory returns: - The FMA is developing a regulatory return tool to gather information to update risk assessments and monitor areas where regulation is light. - The FMA is mapping existing information flows and expects to finalize this process "in the following months" and submit draft returns for industry consultation. - KiwiSaver schemes: subject to additional reporting, including an annual return with prescribed statistical information and notification to the FMA of any fee increase. - Supervisors’ own reporting: Supervisors must deliver operational reports to the FMA at least every six months, summarizing license compliance, interactions with MIS managers and changes in the Supervisor’s circumstances; Supervisors must also certify continued sufficient financial resources, independence and adequate professional indemnity insurance. - Recommendation: When developing regulatory returns, the FMA should consider information already reported to Supervisors to avoid duplication and consider compatible formats for better analysis. ### Systemic risk monitoring - The FMA contributes to identification, monitoring and management of systemic risk and has established the Strategic Risk Committee (SRC) composed of senior staff meeting monthly to discuss emerging risks; strategic risks are recorded in a Risk Register and assessed against the FMA’s overarching risk assessment and prioritization framework. - Strategy and Risk team: 4.8 FTEs; responsible for drafting a monthly Emerging Risk Report identifying risks that are growing or new to the FMA’s perimeter; this report feeds into SRC discussions. - Interagency cooperation: - Council of Financial Regulators (COFR): RBNZ, the FMA, the Treasury and MBIE; meets quarterly; chair rotates between RBNZ and the FMA; objectives include sharing strategic priorities, identifying important system trends, ensuring coordinated action; COFR maintains a risk register. - Trans-Tasman Emerging Risks Committee: engagement with ASIC on priorities and emerging risks of joint interest. - Trans-Tasman Council on Banking Supervision: aims to increase coordination and harmonization of trans-Tasman issues relating to financial stability. - Perimeter review and wholesale markets: - The FMA regularly reviews its regulatory perimeter as part of systemic risk monitoring. - The FMA is developing work on its role in relation to wholesale markets, including a scoping study of market composition, business models and potential risks, clarifying expectations around wholesale market conduct and reviewing access to data on market composition and trends. - The FMA is looking into the size and profile of the wholesale managed fund sector. - Recommendation: The scoping work on the composition and size of the wholesale asset management sector should be promoted. The FMA should continue to explore the profile and importance of the wholesale asset management sector to determine the need to expand the perimeter of regulation. In the near term, the FMA should at least aim to obtain reliable data on the sector to assess its size. *Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17117.pdf* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17117.pdf_