The regulator shouldn’t be funded by those it regulates

Sonnie Bailey

21 February 2020

MBIE and the FMA recently published a Discussion Paper relating to funding for the FMA. (Media release here.) This followed a report from PwC titled “[FMA] efficiency, effectiveness and baseline review”, which was very positive. The authors of the report state that “we consider that the FMA is a high-performing organisation”, and that “there are many indicators that point to resources being used effectively” by the FMA.

To my mind, the MBIE/FMA discussion paper covers two main topics: (a) what level of funding is appropriate for the FMA, and (b) how the FMA should be funded. I made a submission in my personal name. The big themes in my submission are that:

  1. the main stakeholder when making policy decisions like this should be the New Zealand public (and not the industry being regulated); and
  2. funding decisions should be made that promote the independence of the FMA from the industry it regulates, and this is best achieved by funding coming from the Government rather than the industry.

My full submission is below, with some slight amendments (including excerpts in bold) to make it more appropriate for reading on this blog.

Thank you for the opportunity to make a submission in relation to your recent review relating to funding for the FMA.

For background, I am an Authorised Financial Adviser (AFA). I operate an independent financial planning business, Fairhaven Wealth. I am actively involved in the financial advice industry. In the past I have worked as a financial services lawyer. I have also worked in compliance and professional standards roles in the financial services industry.

I am making this submission not on the basis of self-interest but on the basis of what I believe is in the best interests of Kiwis and the financial industry over the long run.

In the submission template, there were various questions. In this letter, I am answering a small sample of these questions, specifically questions 2, 4, and 5. My short answers to questions 2 and 5 are below. I expand on both of these answers in my response to question 4.

2. Which of the FMA funding options do you consider to be most appropriate and why?

Funding option 3: Enhanced case.

If anything, I would support additional funding for the FMA above this level.

The industries that the FMA regulates are complex and impact every single Kiwi. The financial industry is systemically important to our economy. Ensuring it is appropriately regulated is likely to be good for Kiwis in general, good for the economy more broadly, and also for the financial industry over the long run.

5. What is the appropriate Crown/levy split of the FMA’s appropriation and why?

 100% Crown split.

I understand that this is not an option that is entertained in the Discussion Paper. I also acknowledge that this may not be immediately practical. However, as I discuss in relation to question 4 I believe this is the most suitable manner of funding the FMA.

4. Do you think that the proposed additional funding for the FMA should be wholly levy recovered or should the Crown contribute towards the increase? Why?

 The additional funding for the FMA should be contributed entirely by the Crown.

I also believe a significant portion of funding for the FMA that is currently provided by the industry should be funded by the Crown.

Before I expand on this, I want to acknowledge that my direct self-interest would be for my fees to be as low as possible, and this would likely be the case if the Crown funded the FMA entirely. However, I am not making this submission based on self-interest. I would just as readily make this submission if it were against my own self-interest. I make this submission because I believe it’s the right thing for the New Zealand public and for the financial industry over the long run.

The financial industry touches everyone. Having fair, efficient, and transparent financial markets is in the interest of all Kiwis.

I see this submission as relating to two main items that are related but distinct. One relates to the level of funding that the FMA receives in order to undertake its activities to promote and facilitate fair, efficient, and transparent financial markets.

I support the FMA receiving a significant amount of additional funding for this important role. It’s one thing for New Zealand to have good laws and regulations, but they mean nothing if they are not enforced effectively. Effective enforcement requires resourcing, which requires funding.

The level of funding the FMA receives is an important public policy decision. Participants in the financial industry should have a say in this. However, the industry itself is only one stakeholder, and for better or worse, participants in an industry will often be in favour of policy settings that favour themselves in the short- to medium-term rather than what is best for the industry as a whole over the long-run.

There are other stakeholders relating to these decisions, and the most important stakeholder is the Kiwi public.

The second item relates to how this level of funding will be funded. Again, the financial industry is a stakeholder in this decision. However, the method of funding is also a public policy decision which will have ramifications beyond industry participants. It will impact everyday Kiwis, and this needs to be weighed heavily.

I do not believe that the industry that is being regulated should be the major source of funding for the regulator of that industry. This is especially the case with an industry like the financial industry, which impacts all Kiwis and is systemically important to the New Zealand economy.

For one thing, making the industry a major source of funding puts it in a position where it could be seen to be a larger stakeholder in funding decisions – including funding level decisions – than should be warranted.

I have had various conversations with people in the industry on this topic. These conversations have invariably ended up going towards the potential for increased fees and levies, and what people and organisations within the industry receive in exchange for the fees that they pay.

In our user-pays society, this is perhaps natural. However, it creates a relationship where those being regulated might have an expectation that the FMA is working for them and should be providing direct value to them. After all, they are paying for the FMA’s operating costs.

Of course, this is not the case. The industry is only one stakeholder. This is not a suitable relationship between the regulator and those who are regulated. At minimum, this creates a problem of perception that will negatively flavour the FMA’s relationship with members of the industry.

Funding by the industry also creates the potential for conflicts of interest, perceived or otherwise. The FMA might be seen to make decisions that “generate revenue” rather than focus on what is really important. (I have not considered this in detail, but my naïve perception is that there might even in fact be real incentives for the FMA to do this.)

At the very least, the larger the proportion of funding that is generated directly by the industry, the more the industry might be seen as a larger stakeholder in public policy decisions than should be warranted. These include level of funding for the FMA, how it is funded – and, most importantly, in relation to how the FMA is operated,

I want to reiterate: the financial industry is a stakeholder, and the FMA needs to have a good understanding of the industry and how it operates to be an effective regulator. Having an appropriate relationship with industry participants may help it to do its job more effectively. But the industry is not the only stakeholder in this matter. In my view, the financial industry is not even the largest stakeholder. The most important stakeholder is the Kiwi public.

On top of this, my belief is that industry participants will often make arguments that might be in their short- to medium-term best interests, but contrary to their longer-term interests.

When it comes to regulation and the enforcement of these regulations, there is always a risk of “regulatory capture”. (One manifestation of this is that the majority of submissions in relation to this and any other industry-related reports will be provided by people with a direct interest in the industry, rather than Kiwis in general.)

The more reliant the FMA is upon funding from the industry, the greater the potential for regulatory capture.

To use two aphorisms which may be tired but are apt:

  • The tail shouldn’t wag the dog.
  • There should be a strong division between church and state.

In respect to funding levels, and how it is funded, the FMA should be as independent of the financial industry as possible.

As such, I think the FMA’s funding should be primarily funded by the Crown. In an ideal world, the FMA would be funded entirely by the Crown.

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