To preface the following discussion the NZ law looks to be failing to protect retail investors in some important areas.
Whilst the FMA has made a lot of progress in recent years there is still much to be done, not least in terms of protecting retail investors from the ravages of the investment sector.
The unfortunate fact is that whilst the bad guys make the headlines and go to jail the "good guys" inflict 99 per cent of the harm on retail investors where "harm" is defined as bad advice and high fees that professional investors like the NZ Super Fund would not tolerate.
There are a disturbing number of areas where the UK regulator perceives that retail investors' interests are not being well served but which the FMA doesn't see as being a problem.
To be fair the FMA doesn't make the law it just has to do the best it can with what the Government and the MBIE puts in front of it.
We highlighted a good example of these contrasting views a couple of weeks ago in the story "New laws fall short around fund fee disclosure".
Despite being accompanied by high fives and much backslapping the new Financial Markets Conduct Act still does not require fund managers to disclose all their fees and in particular brokerage charges incurred in trading portfolios.
In the UK the FCA quite rightly views these non-disclosed fees as being material and is doing something about it. Therefore, in a complete review of the sector the FCA will be requiring UK fund managers to include transaction costs within a single figure estimate of their annual costs.
Another major area which the NZ regulators views differ from that of the FCA is as regards vertically integrated financial organisations like the banks.
Banks are vertically integrated in that they not only advise client's but they frequently originate the products that clients invest in, like for example managed funds.
The concern is that when advising client's banks will inevitably recommend their own products so as to maximize profitability when there are lower cost and better products available.
This is a very real concern in NZ indeed the union for banking staff was quoted the other day as saying that bank staff were under pressure to sell things like KiwiSaver and insurance and a survey of its members showed that about 60 per cent felt pressure to sell products beyond the customers needs.
The same issues are apparent in the UK and in the FCA's Annual Sector Views report vertically integrated organisations were identified as a problem.
The FCA document said "we have identified the potential for unsuitable advice due to conflicts of interest because of vertical integration".
Meanwhile back in NZ the FMA doesn't see this as an issue indeed the FMA's view is that "putting clients interest first means different things for different organisations.
What it means for an AFA holding themselves out as a non-aligned individual is different to someone with an ASB polo short on, offering ASB products".
What the FMA appears to be saying here is that its interpretation of what "putting a client's interest first" means will be made on the basis what products the firm has to sell.
So if you are a vertically integrated organisation choosing only to sell your own high cost products this is still "putting your client's interests first".
I spoke to Dr Andrew Schmulow (PhD) from the University of Western Australia for his views on vertically integrated organisations like the major banks all of which operate in NZ.
He said "There are far greater pressures here against the vertically integrated model - chiefly that they have caused detriment to customers on an industrial scale, and are by their nature prejudicial to customers.
I simply cannot see how a vertically integrated financial advisory service can ever be in the customer's interests, as there will always be pressure to recommend the bank's own products, and not the 'best' products available."
Lastly one other important area where the FMA's actions or rather lack thereof differs from European regulators is as regards to closet trackers.
Closet tracking is where a fund manager who purports to be active and charges high fees actually invests as per the index.
Research shows that due to the impact of fees these funds inevitably underperform but the reason regulators overseas get involved is because they are misleading investors - purporting to be active, charging high fees but actually not doing much at all.
Regulators in the UK and Europe are conducting major enquires into closet tracking and even going so far as to publicly name and shame the perpetrators.
Contrast these retail investor friendly actions from overseas regulators with what happens in NZ - a number of funds who purport to be active managers and even charge performance fees actually invest a large proportion of their assets in index funds.
Absent any regulation closet indexing is standard practice in NZ.
Here is an example - an active manager which charges 1.5 per cent pa in fees and promotes itself as an active manager actually has 70 per cent of its international share portfolio invested in index funds.
From the fund managers perspective this is a great business decision - one can charge a high active management fee and yet invest in an index fund (which the unitholders pay the fees of) and no research input from the fund manager is required.
Furthermore the fund manager can charge a performance fee relative to a fixed interest benchmark (illegal in the UK) which, because its an index fund, in most years virtually guarantees that the fee will be paid.
If this isn't a deceptive practice I don't know what is.
- Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have an interest in the companies discussed.
