Inside Money

Business writer David Chaplin blogs on personal finance

Inside Money: When things turn to custody: DIMS for dummies

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David Ross, left, and a supporter, leaving after his appearance in the District Court at Wellington. Photo / Mark Mitchell
David Ross, left, and a supporter, leaving after his appearance in the District Court at Wellington. Photo / Mark Mitchell

Last November I noted that the Ross Asset Management (RAM) affair highlighted some of the legal gaps allowing advisers to manage large chunks of money on behalf of clients with little oversight from regulators.

In fact, the rules surrounding discretionary investment management services (DIMS) and the disclosure get-out clause applying to 'wholesale' or allegedly 'sophisticated' investors granted financial advisers considerable power over client money.

To a certain extent legislators were already onto this loophole with some reform of the DIMS rules included in the draft Financial Markets Conduct (FMC) bill, which was a pre-RAM effort.

The Ross scandal, however, hurried the reform program along while also prompting legislators to align the various bits of law governing DIMS - principally, the FMC and the 2008 Financial Advisers Act (FAA).

To that end, the Ministry of Business, Innovation and Employment (MBIE) last week released a discussion document outlining its DIMS ideas and calling for submissions from interested parties.

For example, the FMC bill introduces two distinct types of DIMS: class DIMS, which are akin to traditional broker 'model portfolios' offered to a broad clientbase - these verge on managed fund territory, and; personalised DIMS that are truly tailored investments for individual clients.

Class and personalised DIMS operators will require different licenses under the FMC proposal.

And in a list ranging from a-k, the MBIE paper outlines a number of proposals that have already been drafted into the FMC, currently before parliament, under a supplementary order paper.

The wide-ranging proposals include: standardising the definition of 'wholesale client' across the FAA and FMC laws; bolstering record-keeping and audit requirements; giving further powers to the Financial Markets Authority to set DIMS rules for AFAs, and; allowing the scope of DIMS offered under the FAA to be limited.

But first, and probably foremost, the FMC will require Authorised Financial Advisers (AFAs) who offer DIMS to use an independent custodian "unless otherwise permitted by the terms of their authorisation or by regulations".

As the MBIE document says, lack of adequate custody arrangements "were identified as an area of concern for submitters on the FMC Regulations".

The MBIE paper says custodians can provide DIMS consumers with additional security but only if they have proper safeguards themselves that are communicated to the end client - who probably won't understand what they're talking about.

"The role of custodians is not well understood by retail investors and they often lack the knowledge necessary to ensure that adequate custodial arrangements are in place," the MBIE document says.

Just to clarify for the custodially-ignorant, the MBIE paper includes a useful definition of this important, but sadly-forgotten, link in the money chain:

"Custodians are financial institutions that hold property and money on a client's behalf, execute instructions, and provide information to clients and intermediaries (such as DIMS providers). Custodians can provide an effective safeguard against misappropriation of client assets when custody is provided in conjunction with robust risk management systems and where custodians act as a definitive and independent source of information for clients."

The final DIMS proposals should be known by the end of the year and implemented some time in 2014.

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