Derivatives are complex financial instruments and trading them is not a suitable ‘investment’ for most consumers. Firms issuing derivatives to retail customers in New Zealand must be licensed by the FMA. The sector has approximately 23,000 accounts operated by retail customers.
The ‘Sector Risk Assessment’ report was based on a self-assessment by DIs, as well as the FMA’s interactions with DIs and their clients. All but one* of the 25 licensed DIs participated in the questionnaire.
The report concluded that the risk profile of the DI industry is high. Among the high risk issues identified by the self-assessment were:
- Complying with regulations for handling client money;
- Taking steps to determine products are suitable for retail investors, such as DIs offering exotic options (e.g. binary options);
- Oversight of governance and compliance; and
- Dealing with vulnerable customers.
Medium-high risks included poor outcomes from margin trading, conflicts of interest not being managed, testing of business continuity plans (BCP), and outsourcing of oversight functions.
Other risk areas included board oversight being focused on business interests rather than customers, complacency about conduct and culture, non-compliant advertising, retail customers not understanding fees, and bank DIs.
James Greig, FMA Head of Supervision, said the industry survey was conducted to help the FMA prioritise future areas for the regulator to monitor, while also identifying areas where the sector needs to make improvements.
“This review of the sector gives us a good idea of where to prioritise our monitoring activities. For example, we’ll focus on instances where a DI’s self-assessment was inconsistent with their compliance history, or where it appears the DI’s systems, controls, and practices may not meet our expectations.”
Mr Greig said the report will also help licensed DIs understand the FMA’s focus areas and ensure they comply with the FMA’s expectations and best practice.
Where DIs are not meeting key compliance obligations, the FMA may take action on the DI’s licence, or other enforcement action.
FMA’s enforcement activity in DI sector
Over the past year FMA has taken a number of enforcement actions against derivatives issuers.
- In August 2019, the FMA suspended the DI licence of AxiCorp Financial Services Pty Limited for various Financial Markets Conduct Act disclosure breaches, including making an offer without a compliant Product Disclosure Statement (PDS) and failing to lodge audited financial statements.
- In May 2020, the FMA censured a small DI for various compliance issues relating to its general licence obligations.
- In June 2020, the FMA also filed proceedings against derivatives issuer CLSA Premium New Zealand Limited (formerly KVB Kunlun New Zealand Limited) for alleged anti-money laundering breaches.