The Reserve Bank of New Zealand – Te Pūtea Matua is seeking views on its proposed enforcement principles and criteria.
The proposed enforcement principles will guide the activities of the Reserve Bank’s new Enforcement Department. They are intended to assist in the development of an enforcement framework to achieve its compliance goals, increase the effectiveness of its enforcement actions and promote confidence and consistency in its enforcement decision making.
Who needs to read it and consider making a submission?
The consultation is a must read for registered banks, licensed non-bank deposit takers and insurers, which are subject to the Reserve Bank’s enforcement powers. But other financial sector participants should also take an interest in the Reserve Bank’s intended exercise of its regulatory powers, as it may influence the other regulators.
The Reserve Bank exercises its enforcement powers under a number of statutes that govern the financial sector. They are the Anti-Money Laundering and Countering Financing of Terrorism Act 2009, Reserve Bank of New Zealand Act 1989 (to be replaced in July 2022, when the 2021 Act of the same name and a new Deposit Takers Act come into force), Insurance (Prudential Supervision) Act 2010, Non-bank Deposit Takers Act 2013 and Financial Markets Infrastructures Act 2021.
What are the proposals?
The Reserve Bank says that its enforcement framework will be tied to three compliance goals:
• incentivise and monitor prudent behaviour;
• promote confidence in compliance; and
• enforce compliance by holding institutions to account for non-compliance.
In addition, the Reserve Bank has formulated three enforcement principles and four criteria. These are all high-level, as they are intended to apply across all the areas that the Reserve Bank regulates.
• The three enforcement principles are high-level ideals that guide its enforcement strategy: they are to be risk-based, proportionate and transparent.
• The four criteria are specific considerations for use when deciding on the appropriate enforcement response in each case. They are seriousness of conduct, responsiveness, public trust and confidence and efficacy.
The Reserve Bank says that it has considered similar approaches taken by other regulators, both in New Zealand and overseas. Unsurprisingly, these include the Financial Markets Authority and the Commerce Commission together with the Australian and English prudential regulators. The Singaporean regulatory approach has also been considered.
What do these enforcement principles mean in practice?
The Reserve Bank offers the following examples of how these high-level ideas are intended to guide the way in which it approaches enforcement in particular cases:
Risk-based principle:
The Reserve Bank will focus its efforts and its enforcement resources to address conduct in relation to issues that could have the potential to damage the financial system or the New Zealand economy significantly. Perhaps surprisingly, however, the example given is AML/CFT regulation, which is not obviously an issue that poses the greatest threat to the financial system or the economy (compared, for instance, to the need to ensure that deposit takers and insurers are undertaking only prudent exposures and have sufficient financial reserves).
Proportionality:
The Reserve Bank will determine its enforcement response in a case after considering aggravating and mitigating factors, the broader compliance context and internal and external (i.e. other regulators) precedent. It will seek to apply the regulatory tool that is appropriate for the nature and magnitude of the non-compliance, the particular entity and its general attitude to compliance, the risk posed by the non-compliant activity and the public interest.
Transparency:
Means publishing key guidance and publishing enforcement outcomes unless there are exceptional circumstances that make it inappropriate to do so. It also means engaging openly and honestly with regulated entities during investigations and not publishing them during the investigation phase unless it is appropriate to do so.
What do the criteria tell us?
The Reserve Bank has broken each of its four criteria down into factors, which it will consider when making decisions. These are the following:
Seriousness of conduct.
The Reserve Bank will consider:
• prevalence of non compliance (i.e. whether the entity has a history of breaches);
• magnitude and impact (including whether a breach is technical or whether it has an impact and whether it presents systemic risk or shows up failings in a compliance programme – again AML/CFT is given as an example, which appears to signal a particular focus on that aspect of regulated entities’ conduct); and
• executive or operational knowledge (including whether it was known at a senior level, how long it persisted, and whether there was negligence or recklessness).
Responsiveness.
This includes:
• cooperation with the Reserve Bank in reacting to the breach, including whether it was promptly admitted and fully and willingly disclosed;
• the entity’s compliance history (which seems to duplicate the same point under the seriousness factor and could in our view be omitted from this one); and
• the entity’s conduct in resolving the breach, including any proactive and voluntary remedial action.
Public trust and confidence.
This includes:
• public confidence – whether enforcement action will promote public confidence in the financial system. Interestingly, the Reserve Bank seems to be willing to acknowledge that some enforcement action may risk financial instability, such as a ‘run on the bank’ – a very welcome indication of necessary pragmatism;
• deterrence value – whether enforcement action is likely to modify the behaviour of the entity and others. It is not clear why the Reserve Bank sees this as a factor relevant to public trust and confidence rather than efficacy, which is discussed below – possibly this reflects an expectation that the public may expect a regulatory response in some cases;
• consistency and fairness – whether the enforcement response is consistent with previous action by the Reserve Bank and other regulators; and
• promoting maintenance of the law – whether enforcement will promote regulatory objectives and policy objectives, as well as whether there is a need to clarify the law.
Efficacy.
This includes:
Strength of evidence – the Reserve Bank will be pragmatic about its prospects of success on the evidence, which is practically necessary, but in some cases there may be a tension as a regulated entity may cooperate in the hope of resolving an issue, but in doing so provide the Reserve Bank with the evidence it requires;
Available legal defences – a fundamental and necessary consideration, because if a credible defence is available, no wrong has been committed, in which case the Reserve Bank has no business bringing enforcement proceedings;
Supporting other regulators and working with them when regulatory areas overlap; and
Potential outcomes – the effect upon overall financial system stability (also a consideration under the public trust and confidence factor) and whether the proceeding is likely to result in a conviction, compensation or penalty – and also whether a warning or another lesser response is appropriate.
Our view
There is nothing particularly unusual or remarkable about the three proposed principles, which are broadly consistent with the approaches that other New Zealand financial markets regulators espouse. However, other regulators are more specific about their regulatory priorities.
While we acknowledge that the Reserve Bank says that its principles are intended to be high-level, it offers only one indication of a priority area, AML/CFT regulation.
The FMA, by comparison, is much more specific and recently issued a revised set of priorities in response to the effects of the COVID-19 pandemic, including supporting investors to make good decisions, responding to scams, monitoring treatment of customers in vulnerable circumstances and responding swiftly to market disruptions and significant events.
We think it would benefit financial markets for the Reserve Bank to be more specific about its particular areas of focus so that regulated entities may respond more effectively.
We view the Reserve Bank’s four criteria and the factors underpinning each as largely consistent with the approach taken by the FMA and other regulators.
Where they appear to differ is in the Reserve Bank’s acknowledgement that it must consider the effect that enforcement action may have upon trust and confidence in the financial system generally. The Reserve Bank will be cautious of taking action that may trigger a collapse in public confidence in a systemically important financial institution or in the financial markets generally, possibly resulting in a calamitous outcome. This is not a factor that the FMA or the Commerce Commission are normally expected to take into account when regulating conduct.
The inherent conflict between enforcing conduct rules and preserving confidence in the financial system is one of the key reasons for the separation of conduct and prudential regulation under the “Twin Peaks” model as originally developed in Australia in the Wallis Report, and partially applied in New Zealand. This is reflected in the conflict between the Reserve Bank’s proposed principle of transparency (expressed in its intention to publish the outcomes of its investigations) and its criteria of public trust and confidence (which may be damaged by the same publication).
While we view the emphasis on public trust and confidence as important and consistent with the financial stability goals of the Reserve Bank, it will raise issues because of the inherent conflict referred to above and potential conflicts between the Reserve Bank’s response in particular cases and the responses of other financial services regulators. In our view, this issue should be considered and addressed by all of New Zealand’s financial services regulators, particularly if a rise in class actions notwithstanding the completion of regulatory action is on the horizon.
The emphasis upon AML/CFT regulation is consistent with the focus placed upon it by the FMA and should be taken as a warning that the Reserve Bank will be looking at regulated entities’ conduct in this area carefully.
We welcome the evident pragmatism that is evident from the proposals as a whole.
What’s next?
The Reserve Bank will consider submissions and intends to produce further guidance over the next six months, informed by the principles and criteria outlined above. Submissions will be published unless confidentiality is requested.
If you have any questions in relation to the Reserve Bank’s enforcement approach or about prudential regulation and financial system enforcement in New Zealand generally, please contact one of our experts.
