New Zealand's wholesale investor regime - whole or hole?
21 June 2022
The Financial Markets Authority (the FMA) has recently signalled that an investigation into the treatment of offers to wholesale investors will be on the FMA's regulatory radar for 2022 (and beyond).
Who are wholesale investors, what kind of offers constitute wholesale offers, why is the FMA concerned about these offers and what does it mean for New Zealand businesses and investors?
In March 2022, the new Chief Executive of the FMA made a speech to Financial Services Council Connect in which she signalled the FMA's interest in wholesale offers.
"….we are taking a deeper look at the wholesale investing sector. These investments are on the edge of our regulatory remit and we want to better understand who is investing in these products and the level of risk for investors.
We are particularly focused on whether/ the extent to which vulnerable consumers and people who are, in practice, retail investors are accessing wholesale markets and the harm this may cause them and their families.
This is really important to me, and I would hope that we can work with all of you towards the outcome that only genuinely sophisticated, knowledgeable people access wholesale markets.
As a first step, we’ve requested information from the industry and will publish a report on this during the year. Thank you very much for your engagement in this exercise".1
Who are wholesale investors?
The Financial Markets Conduct Act 2013 (FMCA) and its regulations form the base of New Zealand's primary framework for the regulation of offers of financial products and the provision of financial advice. This article discusses offers of financial products.
Financial products comprise equity securities (such as shares), debt securities (such as deposits), derivatives (such as foreign exchange contracts) and managed investment products (or MIPs) (such as an interest in a KiwiSaver fund).
Wholesale investors are defined in the FMCA. They are persons who meet one or more prescribed criteria in clause three of schedule one of the FMCA. Briefly, wholesale investors are persons/entities who:
Under clause 3(2):
- Are an investment business, being a business whose principal activity is, for example, investing in financial products, or acting as a licensed insurer or a financial adviser
- Meet certain minimum levels of investment activity such that they held or acquired, during the past two years, certain financial products which are valued at NZ$1m or more (in aggregate)
- Are financially 'large' by virtue of having more than NZ$5m in net assets or consolidated turnover for the last two financial years
- Are a government agency, or
Under clause 3(3):
- Are 'eligible investors' by virtue of certifying that they have the requisite experience in acquiring or disposing of financial products that allows them to assess the merits and risks of the transaction, their own information needs and the adequacy of the information provided to them, or
- Subscribe for an offer where the minimum amount payable by the investor on acceptance of the offer is at least NZ$750,000 (or, in relation to an offer of derivatives, the notional value is at least NZ$5m).
If an investor does not qualify as a wholesale investor, they will be a 'retail investor'.
Generally, wholesale investors are considered to be persons/entities who have previous experience in investing, or who are wealthy or large enough that they are better placed than retail investors to assess risks and seek additional information (including financial advice) where required. That said, some sophisticated wholesale issuers voluntarily produce disclosure documents in relation to their wholesale products which are very similar in content (and costs) to those produced for a retail offer.
Proof of wholesale status is important because if an issuer makes an offer to even a single retail investor without complying with the FMCA, serious penalties can apply, including personal and/or criminal liability for directors and/or senior managers. Because of the very serious nature of the penalties, the FMCA gives wholesale issuers certainty of an investor's wholesale status, in the form of a 'safe harbour' certificate. This is a certificate given in a prescribed form by an investor confirming their wholesale status under clause 3(2) of schedule one of the FMCA. It includes a brief mandated warning statement regarding the effects of the investor certifying itself/himself/herself as 'wholesale' and noting that it is an offence (punishable by a fine of up to NZ$50,000) to falsely give a safe harbour certificate. Unless an issuer has reason to believe that the certificate is given falsely, they may rely on the certificate as evidence of the investor's wholesale status for a period of up to two years (unless it is revoked earlier). An issuer does not require a safe harbour certificate in order to rely on the relevant wholesale exemption, however without it, the risk of getting it wrong sits wholly with the issuer. As such, the safe harbour certificate shifts most of this risk from the issuer to the investor.
'Eligible investors' (which are a specific subset of wholesale investors under clause 3(3)(a) of schedule one of the FMCA) are required to give a form of self-certification similar to the safe harbour certificate, except that the mandated warning statement is a little more detailed. The certificate must cover certain certifications and the self-certification must be independently verified by a financial adviser, qualified statutory accountant or a lawyer. There is no 'safe harbour' when relying on this category of wholesale investor. Rather, an assumption is made that the independent professional verifying the certificate does so with due gravitas (noting that it is an offence to incite, counsel or procure a person to give a false or misleading certificate).
Wholesale investors who rely on the minimum NZ$750,000 investment threshold (clause 3(3)(b) of schedule one of the FMCA) are required to be given a mandated warning statement and must separately acknowledge (in a prescribed form) the consequences (for the investor) of the issuer relying on this exemption. Investors who qualify under this criteria are not otherwise required to have any particular level of wealth or experience. We have seen this exemption used (or at least offered) in circumstances where the minimum subscription for the offer is not NZ$750,000 but rather, the investor simply chooses to invest that amount. While background commentary to this exemption does not make this distinction entirely clear, we think the prudent interpretation is that this exemption is intended to apply in circumstances where the offer (versus the investor) meets this criteria. Based on that interpretation, the minimum subscription for participation in the offer by all participants, would need to be NZ$750,000 per investor.
What are wholesale offers?
If an offer of financial products is made only to investors who all qualify (in one way or another) as wholesale investors, it will be a wholesale offer. If the offer is not a wholesale offer (and is not exempt in some other way), it will be a 'regulated offer' requiring, among other things, comprehensive disclosure and, depending on the security being offered, licensing and/or the appointment of a supervisor (see below).
How are wholesale offers treated differently?
Regulated offers of financial products in New Zealand are subject to a number of reasonably onerous requirements. These include disclosure requirements, most commonly in the form of a product disclosure statement (PDS) and a publicly searchable electronic record on Disclose. The Financial Markets Conduct Regulations 2014 (FMC Regulations) set out the required disclosures for all regulated offers of financial products. The requirements are very prescriptive and include specifications as to form, content and length of the PDS. Issuers are also subject to other requirements, including requirements relating to the handling of investors' funds, maintaining and updating certain offer information and complying with financial and other reporting requirements on an ongoing basis. In addition, regulated offers of certain financial products are subject to further requirements including, for example, the licensing of the issuer, the content of the relevant governing document (like a trust deed) and the appointment of an independent supervisor and/or custodian.
The very specific requirements of regulated offers are designed to protect retail investors, principally through the provision of information, but also through mandated protections around the receipt, holding and use of investment monies by the issuer and associated parties and the prescribed content of the relevant governing document. Key information which must be given to retail investors includes information about the risks of the particular offer, summary and full financial information about the issuer (which may be required to look back two financial years, look forward two financial years and/or include a present interim period) and other information which might be considered 'material' to an investor (information is material if it may influence a reasonable investor in deciding whether to acquire the product). Overall, the retail investor regime is meant to offer greater understanding, transparency and accountability for the benefit of retail investors (as opposed to wholesale investors), ensuring that retail investors are provided with essential information to help them make informed investment decisions, presented in a clear, concise and comparable way.
This reflects the purposes of the FMCA in promoting confident and informed participation in the financial markets, promoting fair, efficient and transparent financial markets, providing for timely, accurate and understandable information, ensuring effective monitoring of financial products and services and to reduce governance risks.
Wholesale offers are treated differently under the FMCA, principally because there is no (or very limited) prescribed disclosure and no specific governance requirements. Wholesale offers do not require a PDS and are not lodged on Disclose. The issuer of a wholesale offer is not (usually) subject to ongoing FMCA financial or other reporting requirements (as a result of making the offer). Issuers of wholesale debt securities or MIPs are not required to appoint supervisors or custodians and issuers of wholesale debt or derivatives do not require a licence. In fact, the majority of the FMCA and the FMC Regulations do not apply to wholesale offers or wholesale offerors at all, the notable exception being part two - fair dealing, which prohibits misleading and deceptive conduct.
All in all, as far as the regulatory framework goes, wholesale investors are (currently) largely left to fend for themselves. That is what FMA CEO Samantha Barrass presumably meant when she said that wholesale offers are on the edge of the FMA's regulatory remit. However, as noted in our recent update on the interim stop order issued in relation to a wholesale offer in a Flat Bush property development, that does not mean wholesale offers are, or should be, a 'free for all'. Since that update we note that the FMA has issued a full stop order.
What is the FMA concerned about?
Whether or not there is cause for concern in relation to wholesale offers is yet to be confirmed in a report due to be published later this year by the FMA. However, the FMA is clearly interested in whether and to what extent wholesale offers are being made to the right people.
Wholesale investors are meant to be a class of investor for which the 'regulated offer' framework is unnecessary or unwarranted due to their wealth or experience. The wholesale framework recognises that sophisticated investors are more likely than retail investors to understand and be able to evaluate an offer, including its risks and/or to seek professional advice if they require more information.
Allowing issuers to utilise wholesale exemptions to raise capital means that smaller New Zealand businesses in particular, can access New Zealand capital at significantly lower costs and with less regulatory risk than via a regulated offer. While some form of disclosure is usually provided to investors in the form of an information memorandum or terms sheet, the form and content of that disclosure is not mandated (other than in respect of any relevant warning statements as noted above). While part two – fair dealing in the FMCA still applies, the regulatory burden associated with wholesale offers is otherwise comparatively light.
This is deliberately so and attempts to reach a balance between the information needs of investors considered to be sophisticated and the cost of raising capital. Without the wholesale investor regime, many small and medium businesses in New Zealand would find New Zealand capital too expensive to access. While there are other exemptions available in schedule one of the FMCA, notably, exemptions for close business associates, relatives and 'small (personal) offers', these have limited application for most companies beyond the start-up phase.
The FMA is concerned with ”whether/ the extent to which vulnerable consumers and people who are, in practice, retail investors are accessing wholesale markets and the harm this may cause them and their families". Criticism has been levelled at the wholesale investor regime before. Some argue that merely being wealthy does not make you smart or savvy (with the inference that wealthy people still need the protections of the FMCA). Some argue that the thresholds are set too low and despite the lifting of the 'wealthy' threshold from NZ$2m in the Securities Act 1978 to NZ$5m in the FMCA in 2016, some think the threshold should be higher still, along with a much higher investment activity threshold (one author previously suggested NZ$10m).
It is unlikely that the FMA considers wealth to be a qualifying factor because it somehow makes investors smarter or savvier, or that wealthy investors can afford to lose more money, and we think criticism of that nature should be respectfully disregarded. The wholesale investor framework is about balancing the needs of investors and the needs of small-to-medium businesses. The mandated form of safe harbour certificate explains to investors the consequences of giving the certification (and of giving a false certification), being that they "may not receive a complete and balanced set of information" and they "will also have fewer other legal protections for these investments." The certificate urges the investor to make sure they understand these consequences and to "ask questions, read all documents carefully, and seek independent financial advice before committing..." While it is worthwhile looking at whether the relevant wholesale thresholds remain appropriate over the passage of time, if you believe that being wealthier does not make you smarter or savvier, then simply increasing the thresholds does not appear to be the answer.
Some argue that the eligible investor certification regime is too readily used by investors who sign a certificate as to their eligibility (and have their accountant, lawyer or financial adviser verify it), without really understanding the consequences of certifying themselves to be so. Similar to safe harbour certificates, the warnings contained in the eligible investor certificate are brief but pointed. Furthermore, any professional person verifying an eligible investor certificate would be ill-advised to take that exercise lightly, given the penalties that can apply and the reputational risk involved. At some point, investors who have even a basic level of experience and understanding need to take responsibility for their own actions, read what they are signing, seek professional advice if required and ultimately, not sign a wholesale certificate if they are unsure or ineligible. Perhaps some further education of investors in this regard may be useful.
One aspect of the regime which we suspect could be tightened is the allowance for offers where the minimum amount payable on acceptance of the offer is at least NZ$750,000. This allowance is made on the basis that the investor must have a certain degree of 'wealth' to have this amount of money to invest and that the level of this investment will itself drive adequate due diligence by the investor. It may also recognise that offers for which all investors must invest a minimum of NZ$750,000 at the outset, are likely to be more appropriate for wholesale eyes. However, wealth is already covered by the financially 'large' test (which, incidentally, feels like it is inaptly named/drafted when applied to natural persons). At least the 'large' test requires that the wealth (referenced against net assets) has been held by the investor for at least two financial years. The NZ$750,000 test could in theory capture non-experienced and historically non-wealthy investors who have just come into money (for example, by inheritance or a lotto win). We do not think that is desirable as such investors are no more experienced the day after they acquired this 'wealth' than they were the day before. It also seems remarkable that an investor who meets the 'large' test can subscribe for any value of financial products they choose (subject to any offer specific restrictions) which is often something much less than NZ$750,000. However, an investor who invests in an offer which meets the NZ$750,000 test, who may in fact be less sophisticated or experienced than a 'large' investor, must subscribe for at least NZ$750,000. For these reasons, we query whether this test may need further consideration by the regulators.
Some commentators argue that the wholesale investor regime is simply a convenient pathway for issuers who don't want to take (legal) responsibility. While there will always be participants in the financial markets who push at the edges of regulation and appropriate conduct, for the most part, we do not agree with that assertion. For these kinds of comments to tarnish all wholesale offers would be a shame indeed.
We consider that the wholesale investor regime, as it stands (with possibly a few tweaks), adequately balances the needs of businesses raising capital and the information needs of sophisticated investors. The one proviso to this which the FMA is very much alive to, is whether or not wholesale offers are reaching the right audience. Or perhaps more accurately, whether wholesale offers are reaching the wrong audience.
There is increasing discussion about whether the advertising of wholesale offers should be more tightly regulated. Issuers of wholesale offers will, commonly, advertise an offer publicly in order to reach the maximum wholesale audience. That approach is understandable. To place a restriction on who the offer can be advertised to, akin to the requirements of the 'small offers' exemption (which requires advertising to be made only to those who may have a personal interest in the offer), creates considerable uncertainty for issuers in trying to determine whether someone has a sufficient personal interest and would limit the overall effectiveness and efficiency of wholesale offers.
We can appreciate the FMA's desire to prevent offers which are deemed 'unsuitable' for retail investors' eyes (for example, due to complexity or risk) from being advertised to retail investors. However, the concept of 'suitability' introduces considerable uncertainty for issuers. While further guidance from the regulators may be possible (noting that the FMA has already issued guidance on the advertising of wholesale offers), we think guidance on whether an offer is 'unsuitable' in nature for retail eyes would (necessarily) be reasonably generic and could be challenging for issuers to apply.
As mentioned above, the FMCA already contains an overarching fair dealing regime which is meant to ensure that offers are not misleading or deceptive. Publicly advertising an offer which is not available to the general public, and not making that point very clear in the advertising materials is, in our opinion, likely to be misleading. Whether regulatory intervention is required (for example, in the form of a mandated statement for wholesale advertisements, or requirements as to the placement of particular eligibility information in an offer) or whether the matter can be satisfactorily addressed with FMA guidance, remains to be seen. Presumably, retail investors do not want to waste their time looking at an investment for which they are not eligible and issuers of wholesale offers do not want enquiries or applications from investors who do not qualify. As such, better targeting of advertising should help to reduce the number of investors who are, in the words of Ms Barrass, "in practice retail investors", investing in wholesale offers.
Other measures have also been suggested, such as changing the term 'wholesale' to a term which better describes these investors and offers. 'Wholesale' does, it seem, suggest either some kind of 'discount' when applied to an offer, or connotes a large (and so apparently sophisticated) corporate when applied to investors. Some have suggested that this in itself can mislead retail investors into thinking a wholesale offer is a better 'deal' than a retail offer, or that they are in good company with wholesale investors who know what they're doing (which presumably lends some credibility to the offer). 'Wholesale' is certainly not a natural description for someone who is wealthy or has previous experience investing. Suggestions for an alternative description for these offers include the word 'unregulated'. While that description may be technically accurate using FMCA vernacular and would better impress upon investors the nature of their status or the status of the investment, we do not consider that description to be entirely accurate from a fair dealing perspective. Wholesale offers are not unregulated, they are simply (materially) less regulated than regulated offers.
While commentators search for the perfect word to describe this class of investor and offer, thought should also be given as to how New Zealand compares with equivalent overseas regimes and what it would mean for New Zealand's capital markets if we moved too far out of step with the rest of the world. Our wholesale investor thresholds are already commensurate with (or even higher than) many other similar jurisdictions. If we make the barrier for raising wholesale capital too high, New Zealand companies will be at least tempted to seek capital overseas. Overall, we do not think that is a desirable result.
We agree with the FMA that a review of the use of the wholesale offers regime in the FMCA is probably warranted. Whether there will be any widespread findings of misuse or harm remains to be seen, but issuers have certainly been warned and should be paying particular attention to whether their wholesale offer is appropriately disclosed and advertised, and what steps they have taken to ensure that only true wholesale investors are participating. Equally, we think investors must continue to recognise and assume the personal responsibility that goes with identifying oneself as a wholesale investor.
1 Samantha Barrass, Chief Executive Financial Markets Authority, speech to Financial Services Council Connect on 16 March, 2022.