• The Supervisor
  • Trustees Corporate Supervision

Nov 20, 2023

Regulators set the standard for boards of financial institutions

Thematic review and consultation throw spotlight on governance

September saw the publication of two documents that have significance for boards of financial institutions. The first was the Governance Thematic Review (Review) that was co-published by the Reserve Bank of New Zealand (RBNZ) and the Financial Markets Authority (FMA). The Review describes and analyses a comprehensive survey the RBNZ and FMA undertook together of 29 entities belonging within the regulated banking, insurance, non-bank deposit taking and investment management subsectors of the financial services sector. The second was the Consultation: Proposed liquidity risk management guidance (Consultation) issued by the FMA for which submissions have now closed. The Consultation is directed at managed investment scheme (MIS) managers and their Supervisors. In each case, these documents raise important considerations for the boards and directors of financial institutions, including, but not limited to, MIS managers, other supervised entities, and their Supervisors.

Eight principles for good governance

The Review sets out clear expectations on the part of the FMA and the RBNZ of what they expect from the boards of regulated entities within the financial services sector. It makes plain that the board directors of such entities are intended to read and pay close heed to what the Review has to say, notwithstanding the disclaimer in the Foreword that there is no “’one size fits all’ governance framework” or “single best practice for governance”. The Review states:

The RBNZ and FMA expect regulated entities to have effective governance arrangements to support boards in their crucial role. Such arrangements enable boards to make well-informed decisions, based on sound judgement and in the best interest of the entity, its customers, and its key stakeholders. These expectations are outlined in more detail in our respective governance requirements and guidance, which are now supplemented by this report.

(Review, p. 3) 

Thus the Review, it is clearly spelled out, ranks as supplementary to the legislation and guidance as referenced in its Appendix 2. This is a strong signal as to the weight that the FMA and the RBNZ place on their conjoint publication.

To make things easier for its intended directorial readership, the Review early on sets out a list of eight principles that the RBNZ and FMA want to be considered at board level in regulated financial institutions:

  1. The roles and responsibilities of boards, board and committee chairs and their members are clearly defined, understood and remain fit for purpose.
  2. Boards maintain the collective skills and experience to guide and oversee the implementation of the entity’s long-term strategy and to discharge their roles and responsibilities effectively.
  3. Succession planning is a priority for the chair.
  4. Boards have sufficient independence to support good decision making.
  5. Boards have sufficient diversity to support their role.
  6. Directors have sufficient capacity to fulfil their obligations.
  7. Boards provide effective and appropriate challenge.
  8. A focus on continuous improvement and regular evaluation drives board performance.

(Ibid., p. 7)

Each of the above principles is elaborated on further in the Review, which thereafter sets out the next steps it expects board directors to undertake, including:

We encourage boards of regulated entities that were not part of this Review to assess their governance arrangements against the principles, expectations and good practices outlined in this report. Boards should discuss the outcome of the self-assessment, including which practices they are working towards implementing or have implemented.

(Ibid., p. 8)

The FMA and the RBNZ can scarcely make their intentions for the Review clearer than that. The set of eight principles amounts to a boardroom self-assessment to do list for regulated entities of all sizes - small, medium or large – without exception. In the case of supervised entities, their Supervisors are likely to want to know whether the Review has been promptly considered at their board meetings to the extent that the FMA and RBNZ are urging. These same regulators also intend that the Review will inform the following upcoming policy review initiatives:

  • Standards development for the Deposit Takers Act
  • Insurance (Prudential Supervision) Act 2010 (IPSA)
  • FMA Corporate Governance Handbook, which still remains of relevance

The force and influence of the Review can be expected to be extensive, if not pervasive, throughout the regulated financial services sector. Board directors of regulated financial institutions will need to embrace, understand, and where necessary adapt to the governance climate that the Review has heralded.

Liquidity risk management (LRM) revisited

In April 2020 the FMA published its guidance note Liquidity risk management A good practice guide for Managed Investment Schemes (Current Guidance). The Current Guidance introduced eleven LRM principles, the first of which was entitled “Governance”. In the text that accompanied the governance principle, and also under the eighth principle “Stress testing”, the FMA set out in some detail its expectations for boards of MIS managers concerning their active oversight of LRM. Thus direct board involvement in LRM practices was set down by the regulator as a key requirement for good governance of MIS managers.

The FMA then produced the MIS liquidity risk management review (LRM Review) in June 2021, based on analysis of LRM self-assessments received from 51 MIS managers in August 2020. The LRM Review was critical of the “overly optimistic” and “complacent” attitudes of MIS managers towards their LRM practices. It made LRM a distinct boardroom issue, aiming a considerable part of its critique at the boards of MIS managers in respect of what their directors should be doing to know and understand the workings of the LRM mechanisms their organisation had in place.

For example, the LRM Review stated:

MIS boards/oversight bodies need to maintain effective oversight and provide constructive challenge. This includes forming their own view of the liquidity risk management capabilities, maturity and culture of their entity, and assessing the extent to which these enable the MIS to operate consistently within its defined risk appetite and policy settings. This will allow them to identify any desirable changes, and ensure management takes steps to address those changes.

(LRM Review, p. 4)

It was further stated:

We expect MIS boards to have appropriate oversight of liquidity risk management and stress testing. Senior management and board members are expected to have visibility of their MIS liquidity risk profile, including the potential impact of stress events, and should challenge related risk management frameworks, policies and stress testing results (positive assurance).

(Ibid. p. 6)

As summary findings, the LRM Review concluded:

… [W]e believe that the boards for MIS managers would benefit from further involvement in the stress testing process. We appreciate that some areas are more technical in nature but believe boards should have good visibility of their stress testing practices. This includes reporting and seeking positive assurance on how these are being used to continuously improve liquidity management practices.

We also encourage investment management teams to provide training to their boards (as needed) on how to be more involved in stress tests, and how to challenge them, including in early phases.

The more knowledge a board or governing body has of liquidity concerns at a scheme, fund or manager level, the better prepared they’ll be to provide governance during liquidity events.

(Ibid., p. 15)

The LRM Review contains several statements expressing the FMA’s expectation that boards of MIS managers will study the document and act upon it. The document reflects the standards the regulator had set for these boards regarding LRM as at mid-2021, which standards still currently apply. These standards extend well beyond directors of MIS managers having general acquaintance with the LRM methodologies employed by their entities to requiring detailed technical knowledge of the liquidity management tools (LMTs) available, assurance processes used, and capacity to challenge stress testing results effectively. An upgrade in the skills of directors with respect to governance over LRM matters is explicitly recommended in the form of inhouse training provided by investment management expertise. Accordingly, there is already a set of FMA-initiated high standards in place for MIS manager boards concerning LRM, but now the regulator seeks to raise the bar further still.

FMA consultation on LRM in late 2023

Just over two years on from the advent of the LRM Review, the Consultation published by the regulator proposes that the Current Guidance should be updated and replaced by a new version (Proposed Guidance), the text of which it includes. In part the need for a new LRM guidance has arisen because in the interim since the Current Guidance and the LRM Review came out, some major and inter-related pieces of work on LRM have been undertaken by the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB) that the Consultation makes reference to:

Thematic Review on Liquidity Risk Management Recommendations Final Report (IOSCO, November 2022)

Assessment of the Effectiveness of the FSB’s 2017 Recommendations on Liquidity Mismatch in Open-Ended Funds (FSB, December 2022)

Addressing Structural Vulnerabilities from Liquidity Mismatch in Open-Ended Funds – Revisions to the FSB’s 2017 Policy Recommendations Consultation report (FSB, July 2023)

Anti-dilution Liquidity Management Tools – Guidance for Effective Implementation of the Recommendations for Liquidity Risk Management for Collective Investment Schemes Consultation Report (IOSCO, July 2023)

A significant purpose of the Proposed Guidance is to integrate into MIS manager LRM practices the substantial efforts on improving LRM standards and methodologies that the FSB and IOSCO have made in co-operation recently.

In conjunction with this integrational purpose, the FMA has used the Proposed Guidance to place much more emphasis on LRM as a legal obligation of MIS managers and their Supervisors. One of the key objectives of the Proposed Guidance is stated as being to, “Communicate the view that having, and overseeing, effective LRM is a legal obligation of MIS managers and Supervisors respectively” (Consultation p. 2). This statement is augmented by another objective, which says that the Proposed Guidance is seeking to, “Note areas where we would like to see some MIS managers and Supervisors do more, particularly relating to monitoring and tools to manage liquidity risks in normal and stressed market conditions. This includes both MIS managers and Supervisors being more proactive and engaged with LRM, and schemes defining the term ‘illiquid assets’” (Ibid., pp. 2-3).

Within the Proposed Guidance, LRM is early on implicitly linked with the FMC Act’s section 143 (1) (b) (i) and (ii)  black letter legal obligations for MIS managers to act in the best interests of their scheme participants and treat them equitably. Thus the Proposed Guidance states:

The cornerstone of this guidance is our overarching expectation that investors are appropriately protected and treated equitably. The guidance is not intended to prescribe how MIS managers and Supervisors demonstrate they are meeting their legal obligations for LRM. Rather, it sets out the features that we expect MIS managers to consider when designing and operating LRM for their MIS.

MIS managers are responsible for determining what LRM practices are appropriate for the schemes they manage, and in doing so must act in the best interests of scheme participants and ensure they are treated equitably. Supervisors are responsible for overseeing MIS managers’ LRM practices.

(Ibid., p. 2).

The strong implication of the quoted passage above is that failures on the LRM front by MIS managers could readily escalate into breaches of s.143, with serious business ramifications to follow. Board directors of MIS managers would do well to take note of the risk potential from this severe legal hazard and regard it as a stimulus to sharpening up their oversight capacities for LRM.

Features replace principles for directorial attention

One notable change in the Proposed Guidance when compared with the Current Guidance is that in the former “features” are now substituted in place of the latter’s “principles”. The substitution is announced without further comment in both first sentences of the Consultation’s frontispiece and of the Proposed Guidance, wherein “essential features” are referred to, although it is stated, as quoted above, that the FMA expects MIS managers to “consider” these features “when designing and operating LRM for their MIS.”

By contrast, the Current Guidance offers “a set of good practice principles to strengthen MIS liquidity risk management capabilities and practices.” These principles are stated to be “directed at the level” of MIS managers. Arguably, features, being embedded in LRM, as opposed to principles as external factors, are more imperative for MIS managers to attend to. The principles have more of a take-it-or-leave-it ambience about them, whereas there is an implication that lack of any of the essential features in LRM would require some explanation by the MIS manager who omitted them.

In line with the Current Guidance’s 11 principles, the Proposed Guidance promotes 11 features:

  • Feature 1 – Overarching framework and strategy
  • Feature 2 – Governance
  • Feature 3 – Contingency plans
  • Feature 4 – Product design
  • Feature 5 – Disclosure and communication
  • Feature 6 – Monitoring framework
  • Feature 7 – Liquidity management tools
  • Feature 8 – Stress testing
  • Feature 9 – Use of leverage to adjust risk/return
  • Feature 10 – Record keeping, data and systems
  • Feature 11 – Evaluation and review

Boards of MIS managers have their work cut out for them in the Proposed Guidance, with explicit mentions of their expected roles evident in Features 2, 6, 7, 8, and 11 as tabulated:


Board role

Feature 2 – Governance

Approval and ongoing review; Reporting and oversight; Integration into wider risk management

Feature 6 – Monitoring framework

Illiquid assets oversight

Feature 7 – Liquidity management tools

Using LMTs

Feature 8 – Stress testing

Governance and oversight

Feature 11 – Evaluation and review

Regular review

In shades of value-for-money (VfM) assessments, Features 2 and 11 require that MIS managers’ boards should regularly review and approve LRM frameworks and practices at least annually. Supervisors of such entities would be wanting to receive evidence of such regular reviews being completed.

LRM-related jobs for Supervisors

Like the Current Guidance, the Proposed Guidance comes with a set of LRM-related tasks for Supervisors to perform in the best interests of scheme participants. These tasks can be summarised as follows:

  1. Undertaking regular assessments at fund level of MIS managers’ LRM frameworks and liquidity stress resiliencies, using a tailored risk-based approach that includes the likes of frequency, scope, and intensity;
  2. Monitoring MIS managers’ internal reports, market information and periodic surveys in combination to supplement regular assessments;
  3. Frequently reviewing MIS managers’ own liquidity-related monitoring activities to detect any changes; 
  4. Clearly identifying the LRM-related triggers that may prompt reporting to the FMA under section 203 of the FMC Act.

“The two papers discussed in this month’s article raise a number of issues of importance for boards of supervised entities and their Supervisors to pay attention to,” said Matthew Band, General Manager of Trustee Corporate Supervision at Trustees Executors.

Governance Thematic Review

“The RBNZ/FMA’s Governance Thematic Review should be regarded as required study by directors of supervised entities in preparation for detailed discussion at the boardroom level.”

“This Review provides appropriate tools for boards of regulated financial institutions to conduct constructive critical reviews of their governance best practice standards and methodologies.”

LRM consultation

“With respect to LRM, MIS managers and their boards should be looking very closely at the FMA’s Consultation on its Proposed Guidance.”

“There is a lot of potential legal and business risk inherent in what the regulator has been consulting on in terms of its expectations of MIS managers and the eleven LRM features that it wants to replace the current eleven LRM principles with.”

“Boards of MIS managers need to ensure that they are fully cognisant not merely of what they are expected to do under the Current Guidance and its companion LRM Review, but also of how that could change under the Proposed Guidance.”

“Integration of latest international trends into LRM as practised within New Zealand, strengthened FMA emphasis on legal obligations of MIS managers and their Supervisors arising from LRM, and the fine granularity with which the regulator expects MIS managers and Supervisors to address their respective LRM-related tasks, taken together mean that the Proposed Guidance is a significant document to read.”

“Trustees Executors has contributed to submissions to the FMA on LRM in conjunction with the Corporate Trustees Association (CTA).”

“As a Supervisor, regardless of whether the Consultation’s outcome results in the Proposed Guidance or something similar being finalised as the new current LRM standard, Trustees Executors will be monitoring the LRM activities of its MIS manager clients, including of their boards, to assist with ensuring that they meet the required standard prevailing.”

For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matt Band at [email protected].

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