Twin Peaks

by Ingrid Goodspeed, Governor of the South African Institute of Financial Markets

Introduction

South Africa’s shift to the twin peaks financial sector regulatory framework was proposed in National Treasury’s policy document A safer financial sector to serve South Africa better in February 2011. The proposal, adopted by Cabinet in July 2011, is to separate prudential and market conduct regulation and supervision and is structured around the following policy objectives:

• Preserving the stability of the financial system as a whole
• Maintaining the safety and soundness of regulated financial institutions and market infrastructures
• Protecting consumers of financial products and services and ensuring financial institutions treat their customers fairly
• Expanding access to appropriate financial products and services to ensure the financial inclusion of all South Africans
• Combating market abuse and financial crime and ensuring the integrity of the financial sector.

Implementation of the model is a two-phase process. The first phase involves developing and promulgating overarching legislation i.e., the Financial Sector Regulation Act (FSR Act) to empower the prudential and market conduct regulators to deliver on their mandates. The second phase comprises harmonising financial sector legislation such as the Banks Act, Long- and Short-term Insurance Acts with the FSR Act and developing conduct of financial institutions legislation. The expected completion of phase one is 2017 – the FSR Bill was passed by the National Assembly on 22 June 2017 and signed into law by the President on 21 August 2017. Phase two work has already begun with the drafting of the Insurance Bill (tabled at Parliament in 2016) and the Conduct of Financial Institutions (COFI) Bill (due for release for public comment soon, possible still in 2017). The rest of phase two may take a number of years. An overall timeline for implementation has not been published.

Current financial regulatory and supervisory framework

The current framework for financial regulation and supervision in South Africa is complex with a number of regulators – see figure 1 for a simplified depiction. The main regulators are Bank Supervision Department (BSD) of the South African Reserve Bank (SARB) and the Financial Services Board (FSB-SA). BSD prudentially regulates and supervises banks and the FSB-SA most non-bank financial institutions as well as securities markets, where it relies on self-regulatory organisations such as the JSE and Strate. The National Credit Regulator (NCR) regulates the market conduct of all credit providers (banks and non-banks) and the National Consumer Commission (NCC) the market conduct of all consumer goods and services providers as well as banks (other financial services firms have been exempted). To add to the complexity, financial sector regulators are to varying degrees subject to the authority of two government departments. The Department of Trade and Industry oversees the NCR and NCC, while BSD has a direct reporting line to the Minister of Finance on legislative issues and FSB-SA is subject to the general authority of the Minister of Finance.

The future twin peaks regulatory and supervisory framework

The twin peaks model is characterised by separate prudential and market conduct regulators. Since equal weight is given to prudential and market conduct regulation, it is regarded as the optimal way to ensure that consumer protection and market integrity receive sufficient priority and are not routinely presumed to be subservient to prudential concerns.

Market conduct regulation focuses on protecting customers that buy financial products or otherwise entrust funds to financial institutions. Such regulation provides consumer protection by addressing the unequal position of financial institutions relative to their customers. The most vulnerable customers are retail clients who often lack the sophistication and information necessary to protect themselves from fraud, market abuse or ill-informed advice and rely on financial institutions and their representatives to look after their interests. Under twin peaks this responsibility will be carried out by the Financial Services Conduct Authority (FSCA). Apart from protecting consumers, the FCSA will be required to promote confidence in the South African financial system and ensure financial services institutions and markets function well and to high ethical and professional standards.

Of course prudential regulation also seeks to protect consumers, investors and depositors. Prudential regulation is applied to financial institutions such as banks, securities firms and insurance companies to ensure that they are financially sound and capable of meeting their obligations to customers. Regulators are interested in the health and strength of these financial institutions as the failure of one or more of them could result in a loss in confidence in the safety and soundness of the financial system. In South Africa the prudential regulator will form part of the SARB, which will be responsible for both micro- and macro-prudential regulation and supervision. Micro-prudential regulation aims to secure the safety and soundness of individual financial institutions and will be the responsibility of the SARB’s prudential authority. For practical reasons, the prudential regulation of “prudentially-insignificant” firms such as collective investment schemes and micro-insurers will be done by the FSCA. For pension funds, prudential regulation and supervision will presumably be ring-fenced within the FSCA. These exceptions may add complexity to the model.

Macro-prudential regulation seeks to promote and enhance the stability of the financial system as a whole and will be the responsibility of the SARB itself together with conglomerate supervision and crisis management and resolution.

The twin peaks model in South Africa is further characterised by:

• Mechanisms for cooperation and consultation across government and all financial sector regulators to promote consistency and coordination in delivering policy objectives
• A harmonised system of licensing, supervision, enforcement, consumer recourse (ombuds schemes), and appeal mechanism (financial services tribunal).
• An emphasis on pre-emptive, risk-based and outcomes-focused approaches to regulation.

A simplified depiction of the model is shown in figure 2.

The overarching regulatory and supervisory principles to be implemented are:

• transparency with regard to regulators’ decisions, actions and approaches;
• comprehensive coverage of financial services activities and consistent principles and rules for comparable activities;
• appropriate, intensive and intrusive supervision;
• principles- and rules-based regulation to achieve regulatory outcomes;
• risk-based and proportional regulatory and supervisory approaches;
• pre-emptive and proactive frameworks that enable regulators to identify and mitigate emerging risks;
• credible deterrence in that regulators have and use the authority to enforce adherence to principles and rules; and
• appropriate alignment with international standards.

The PA and FSCA receive their mandates and powers from government policy and legislation enacted by parliament. They are accountable and operationally independent¹ within this mandate. Appropriate governance framework to oversee them will include (i) a regular flow of information, including actual performance against objectives, to the National Treasury; (ii) strategic and annual performance plans as well as annual reports tabled in Parliament through the Minister of Finance; and (iii) regular external audits. The PA will operate within the SARB and be subject to the SARB’s governance arrangements. The FSCA will be governed by a full-time commissioner and executive management team appointed by the Minister of Finance. Independent audit, remuneration and risk committees will have administrative oversight.

Issues still to be addressed

The major issue to be addressed under the twin peaks model is the role of the NCR. Agreement between National Treasury and the Department of Trade and Industry as the disposition of NCR has yet to be reached. Clearly it would be preferable for South Africa to have only one market conduct for financial services. This will ensure consistent market conduct standards in terms of licensing, fit and proper requirements, disclosure, consumer recourse and enforcement across the financial services industry, which will avoid confusing consumers, inviting unintended consequences such as regulatory arbitrage and burdening market participants with unnecessary compliance costs such as different management information and reporting systems for credit versus other financial products.

Medical aid schemes are not addressed in the proposed twin peaks model. Since the management of these schemes require financial expertise and that they are often underwritten and managed within financial conglomerates it would be in the interests of customers to incorporate them.

The Twin Peaks approach to financial regulation separates regulatory functions by objectives, thereby allowing each regulator to focus on a single core mandate. Yet the prudential regulation of certain institutions will be allocated to the FSCA. It may be necessary to elaborate why this approach is considered appropriate.

Cost of twin peaks regulators

The twin peaks regulators established by the FSR Act will be primarily funded through levies imposed on financial institutions and fees for services provided by the regulators. National Treasury together with the SARB and FSB-SA have prepared a detailed costing of twin peaks regulators. Estimated fees and levies, which will be implemented through the Financial Sector Levies Bill (tabled to Parliament in November 2016), are shown in the table below.

There are concerns that these levies and fees as well as the costs of increased compliance requirements for regulated entities in terms of licensing, reporting and funding will increase compliance costs and hence the costs passed on to customers.

National Treasury believes benefits of the new regulatory model outweigh the costs. These benefits include:

• Maintaining financial stability and correspondingly protecting the financial system from the substantial costs associated with systemic crises;
• Greater harmonisation, consistency and coordination; reduced duplication and elimination of contradictory requirements across regulators
• A more level playing field for financial institutions and removal of regulatory arbitrage
• Alignment to international best practice
• Financial soundness and robust capital management
• Enhanced expertise and efficiency of regulators
• Improved consumer trust, confidence and satisfaction
• Better consumer protection, awareness and recourse mechanisms

Conclusion

The implementation in South Africa of the twin peaks model has two fundamental objectives to (i) strengthen South Africa’s approach to consumer protection and market conduct in financial services and (ii) create a more resilient and stable financial system. Introducing a new model of financial regulation is not a simple task and will require effective planning to ensure risks are managed and effective supervisory oversight remain in place throughout the transition.

Bibliography

National Treasury. February 2011. A safer financial sector to serve South Africa better. Available at www.treasury.gov.za/twinpeaks. Accessed August 2017

National Treasury. February 2013. Implementing a twin peaks model of financial regulation in South Africa. Available at www.treasury.gov.za/twinpeaks. Accessed August 2017

National Treasury. November 2016. Supplement to the impact study of the twin peaks reforms. Available at www.treasury.gov.za/twinpeaks/. Accessed August 2017

Websites (accessed August 2017)

https://pmg.org.za/bills/current/

[1] To be operationally independent regulators and supervisors must be free from both political interference and regulatory capture by the industry.