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Financial Regulation Update – February 2018

Home Insights Financial Regulation Update – February 2018

Contributed by:

Contributed by: Polly Pope, Emmeline Rushbrook, Will Irving, Joanna Khoo and Mark Calderwood

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Published on: February 23, 2018


High Court addresses the state of the "penalty" rule in New Zealand

The High Court has considered the state of New Zealand law relating to penalties in detail for the first time since developments in Australia (Paciocco) and the United Kingdom (Cavendish). (The Court of Appeal's decision in Wilaci Pty Ltd v Torchlight Fund No 1 LP (in rec) [2017] NZCA 152 addressed New South Wales law.)

Honey Bees Preschool Ltd v 126 Hobson Street Ltd [2018] NZHC 32 concerned a lease for a pre-school. The lessor agreed to install a second lift in the premises within a certain timeframe, failing which the lessor would indemnify the tenant for all obligations under the lease until expiry. In substance, on its face, if the second lift was not installed, the tenant was entitled to rent-free occupation.

While the facts are therefore relatively unusual, Whata J took the opportunity to review the state of the law in New Zealand. His Honour held that:

  • as to scope, the penalty rule should affix only to secondary obligations (including collateral or accessory obligations) to compensate or make good on the breach of or failure to discharge primary obligations. This endorses the UK position in Cavendish in preference to the Australian position in Paciocco;
  • the central issue is whether a stipulated remedy for breach is out of all proportion to the legitimate performance interests of the innocent party, or otherwise exorbitant or unconscionable, having regard to those interests;
  • however, a comparison between the pre-estimate of loss and the stipulated sum should not be "jettisoned altogether" and, in appropriate cases (ie, where there is a stipulated sum), can sit alongside the above formulation of the "central issue". In the UK and Australia, this comparison has been substantially qualified, and the High Court's judgment on this point reflects that there remains binding New Zealand Court of Appeal authority that endorses this comparison; and
  • other relevant factors include:
    • whether the parties were commercially astute, had similar bargaining power and were independently advised; and
    • whether the predominant purpose of the impugned clause is to punish (as opposed to simply deter) non-performance.

In the result, the Court held that:

  • the indemnity fell within the scope of the penalty rule, and was therefore open to scrutiny. While it was argued for the lessee that an indemnity is a primary obligation, Whata J considered that, in substance, the obligation to indemnify corresponded to a breach of a primary obligation (to install the second lift); however
  • on the application of the factors identified above, the indemnity did not infringe the penalty rule.

His Honour went on to hold, however, that at this stage, the indemnity should only apply until the date of installation of the second lift. Equitable relief against forfeiture was not argued and may be appropriate, given that, in effect, the lessor was obliged to forfeit all rental and outgoing payments. The parties were given leave to argue this point.

FMA releases Conduct Outcomes Report

The FMA has released its second annual Conduct Outcomes Report. As well as being a roundup of misconduct identified by the FMA during 2017, the Report contains some indications of the FMA's focus for 2018 and beyond, and provides fresh insight on what drives the FMA's enforcement responses in particular situations. 

Enforcement action

Regular readers of Financial Regulation Update will find many of the names mentioned in the report familiar: Warminger (market manipulation), EROAD (insider trading), Prince and Partners (trustee company supervision), and Innovative Securities (deregistration from the FSPR) are some examples.  


In terms of trends and developments, the FMA has become aware of scams associated with initial coin offerings (ICO), which were taking advantage of increased consumer interest in digital currencies. In the same space, the FMA took action in respect of an ICO (called Sell My Good) where it was not able to assess the ICO before the tokens went on sale, but believed it should be classed as a financial product. The FMA engaged with the directors and they voluntarily stopped the ICO and refunded all money to investors.

This highlights the importance of taking advice to determine whether and how an ICO is regulated, and the FMA expressly notes that it is its expectation that those offering tokens via an ICO will take formal advice.

Investor survey

One interesting feature of the Report is that the FMA has, for the first time, surveyed investors about their experience of financial service providers' conduct. The two areas where investors' perceptions were the worst were in relation to whether their financial provider:

  • "explained the fees" (with only 53% agreeing); and
  • "helped me understand why the product was appropriate for me" (with only 52% agreeing).

This may be an indicator of future areas of focus for the FMA.

A full copy of the Report is available here.

FMA opens applications for personalised digital advice

On Thursday, the FMA announced that it is now accepting applications from providers seeking an exemption from the Financial Advisers Act 2008 (FAA) to allow them to provide personalised digital advice (robo-advice) to retail clients.

Providers of personalised financial advice and personalised investment planning services provided through a digital advice service will be able to apply for an exemption to the FAA. Applicants will need to comply with a number of requirements, including requirements associated with having:

  • directors and senior managers of good character;
  • the capability to provide personalised digital advice effectively;
  • adequate risk management processes;
  • secure and reliable IT systems; and
  • systems that effectively filter out clients that are not suited to digital advice.

The exemption will be subject to a number of conditions, including to disclose certain information to clients, to comply with certain code standards, to keep records of the digital advice services provided and to notify the FMA in writing as soon as practicable after forming the belief that a material change of circumstances has or may have occurred, or is likely to occur.

More information about how to apply for an exemption can be found here. The exemption will be revoked when the new financial advice regime under the Financial Markets Conduct Act comes into force, replacing the existing FAA regime. This is expected to occur in 2019.

Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry

On 30 November 2017, the Australian Prime Minister, Malcolm Turnbull announced that the Australian government would establish a Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission). The Royal Commission is being led by retired Australian High Court Judge, the Honourable Kenneth Hayne AC QC.

The terms of reference define "financial services entity" broadly to include:

  • authorised deposit-taking institutions;
  • insurers;
  • persons or entities holding a financial services licence; and
  • persons or entities holding themselves out as acting as an intermediary between borrowers and lenders.

The terms of reference can be found here. Terms of reference are also broad in terms of what misconduct the Royal Commission may examine, including conduct:

  • that constitutes an offence against Commonwealth, State or Territory law;
  • that is misleading, deceptive, or both;
  • that is a breach of trust, breach of duty or unconscionable conduct; or
  • that breaches a professional standard or widely adopted benchmark for conduct.

The first hearing of the Royal Commission commenced on 12 February 2018 and covered preliminary matters. The next series of public hearings will take place in approximately one month and is due to address inappropriate lending practices in terms of mortgages, car loans and credit cards. A draft report from the Royal Commission is due to be submitted by 30 September 2018 and a final report by 1 February 2019.

This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.

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