INTRODUCTION In 2016, the New Zealand Ministry of Health introduced the System Level Measures (SLM) framework as a new approach to health system improvement that emphasised quality improvement and integration. A funding stream that was a legacy of past primary care performance management was repurposed as 'capacity and capability' funding to support the implementation of the SLM framework. AIM This study explored how the capacity and capability funding has been used and the issues and challenges that have arisen from the funding implementation. METHODS Semi-structured interviews with 50 key informants from 18 of New Zealand's 20 health districts were conducted. Interview transcripts were coded using thematic analysis. RESULTS The capacity and capability funding was used in three different ways. Approximately one-third of districts used it to actively support quality improvement and integration initiatives. Another one-third tweaked existing performance incentive schemes and in the remaining one-third, the funding was passed directly on to general practices without strings attached. Three key issues were identified related to implementation of the capacity and capability funding: lack of clear guidance regarding the use of the funding; funding perceived as a barrier to integration; and funding seen as insufficient for intended purposes. DISCUSSION The capacity and capability funding was intended to support collaborative integration and quality improvement between health sector organisations at the district level. However, there is a mismatch between the purpose of the capacity and capability funding and its use in practice, which is primarily a product of incremental and inconsistent policy development regarding primary care improvement.