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Advice rules created 'two-tier' market, working group says

More advice is needed to boost the fortunes of the New Zealand capital markets, a new report says.

Tuesday, September 10th 2019, 6:00AM

The Capital Markets 2029 working group has released its recommendations to rejuvenate the NZX.

Among them are the suggestion that KiwiSaver members be allowed to self-direct and invest with multiple providers, mandating employers' contributions, reinstating a kickstart payment for members who are older than 18, changing tax rules to make KiwiSaver contributions and returns tax-free, simplified disclosure requirements for regulated offers, a review of continuous disclosure liability settings, and a centralised process for AML.

But it also called for changes to the way advice is delivered.

It said the FMA should issue guidance in respect of what was expected of advisers offering advice on shares.

"Financial advisers are hesitant to recommend equity products where research is not readily available, even though this was not the intention of the current legislation.

"This means that many small market capitalisation stocks receive limited focus by the broking community."

Regulation of financial advisers had been effective in upskilling advisers, it said and those who specialised in capital markets were paying closer attention to asset allocation and portfolio construction.

"The advisers that specialise in capital markets, closer attention to asset allocation and portfolio construction for retail investors has been a focus."

But it said the requirement that advisers have reasonable grounds to recommend a product had been interpreted conservatively as requiring  in-house research, produced by analysts with the institutional research divisions of their firms, in order for an adviser to recommend a security.

"Broking firms reached this conclusion in order to mitigate risk for their firms, for their advisers and ultimately for their clients. As a result, to varying degrees, retail advisers and broking firm wealth managers have concentrated on larger, more liquid financial products that are covered by research analysts."

But the group said a guidance note from the FMA saying that reasonable grounds need not always mean research had been ignored.

"The industry response to these regulations has, in effect, led to the emergence of a two-tier local equity market. There is a concentration of retail investors in larger stocks and reduced interest and liquidity of smaller stocks. It can be argued that advised retail investors have not been, in the circumstances, harmed by the implementation of the advice regime. However, it has had some opportunity cost: It has reduced the number of New Zealanders who have access to advice, both generally and within the capital markets, thereby reducing direct retail investor participation, it has created significantly lower levels of interest and liquidity in smaller stocks, and it has affected the productivity of advisers."

The group said it also made it much more difficult to list smaller companies. Advisers were generally more reluctant to recommend clients to participate in IPOs if their firm was not providing research, or due to the likelihood of the lower liquidity of shares of smaller IPOs, and the fact research coverage, if any, may not be enduring.

"The mixed performances of IPOs launched in 2014–16 has also done little to shift this reluctance."

The group said the new code of conduct for financial advisers and its application to investment advisers could be made much clearer with the issue of formal guidance notes.

The group also said KiwiSaver providers should help members with financial advice at different life stages, from getting them into the right fund when they start, to buying their first home, and planning for retirement.

"Members should not be left waiting until they reach 65 to decide what they should do, as is the case for many today. Getting into an appropriate fund when first joining KiwiSaver can make a significant difference to a KiwiSaver’s outcome in the long term. More effort from providers to offer a range of advice services is essential."

The Commission for Financial Capability and Financial Markets Authority were well-positioned to support the development of educational tools and provide regulatory direction, it said.

"Changing regulations have definitely improved the quality of advice to retail investors but have reduced access to that advice. In general, average KiwiSaver balances are yet to reach the point where it is economic for an AFA to provide bespoke advice to the average member. The emergence of robotic advice may increase access, but there is still an issue regarding independence of platforms and the range of products offered."

Commerce and Consumer Affairs Minister, Kris Faafoi, said key areas of opportunity have been highlighted by the report.

“The report indicates areas where our capital markets are working well, and this is pleasing to see. New Zealand’s equity market has shown good growth in comparison to global counterparts, and our debt and secondary markets are performing well.

“In addition, KiwiSaver is growing the domestic pool of savings which are available to invest in New Zealand,” Faafoi said.

“There are a number of areas where work is already under way and the recommendations made by the working group will be taken into account as work progresses.

The NZX and FMA also welcomed the report.

“We are particularly pleased to see the emphasis on making our capital markets more accessible and relevant to New Zealanders, because about three million of us are already participating through KiwiSaver – with this nest-egg expected to grow four-fold over the next 10 years to more than $200 billion. Technology is also breaking down some of the traditional barriers to investment, with online investment platforms such as Sharesies allowing people to get started from as little as $5, the cost of a single cup of coffee," said chief executive Mark Peterson.

Chairman James Miller and FMA chief executive Rob Everett said the report would be carefully considered.

Working group chairman Martin Stearne said the issue of advice had been raised early in the process.

He said financial capability was the biggest consideration. "There's access to advice if people are willing to pay for it. The greatest barrier has been the propensity of people to pay for it."

But he said the advent of roboadvice would help and there were an increasing number of players who worked to introduce people to capital markets and "hold their hands" through the process.

Tags: capital markets Commission for Financial Capability equities financial advisers FMA IPO KiwiSaver Kris Faafoi NZX regulation roboadvice

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Last updated: 16 September 2019 10:03am

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