The Financial Services Board (FSB) provides more information on the phasing in of the Twin Peaks regulation model, in Issue 2 of its Twin Peaks Newsletter.
The newsletter provides clarity on the objectives of the Financial Sector Regulation (FSR) Act, which is seen as the foundation of the Twin Peaks model, and the changes or amendments to the new regulatory system it will introduce. The model intends to grant the Financial Services Conduct Authority (FSCA) and the Prudential Authority (PA) powers to enforce appropriate regulation.
The newsletter also analyses the powers of the two peaks, reveals how the FSCA and PA differs and how they will affect stakeholders.
Below are the articles that appear in the Twin Peaks newsletter. (For the original newsletter, click here)
1. Twin Peaks is now a reality
Now that the FSR Act is approved, the envisioned Twin Peaks architecture is now a reality but what does that mean for regulated entities and when will the changes start to be felt?
1.1 The FSR Act
The FSR Act not only designs the architecture for supervising the financial sector but also shifts the approach and mandate of the conduct authority which essentially amounts to an overhaul of the regulatory approach.
FSR Act introduces the Prudential Authority (PA) under the South African Reserve Bank (SARB) and determines that the FSB will become a dedicated market conduct supervisor over all financial institutions. The first change that will be seen or felt by the sector will be in the Insurance space. All of the staff in the current Insurance Prudential Department will move to the SARB in October. They will still report to the FSB and fall under Caroline Da Silva who is the acting Deputy Executive Officer for Insurance at the FSB. They will continue to report to the FSB under the current Long-term and Short-term Insurance Acts until the PA goes live which is anticipated to be at the end of the 1st quarter of 2018. Insurance Bill is the law that will govern the prudential aspects of insurance and this is currently going through the Parliamentary processes. As soon as this Bill is promulgated all insurers will be subject to this Act for prudential purposes.
They will also however be subject to the current Long-term and Short-term Insurance Acts as amended by the FSR Act and the Insurance Bill for market conduct purposes.
In other words, what will remain with the FSB and the future FSCA is the market conduct aspects of the current Insurance legislation. This includes the Policyholder Protection Rules, which are in the process of being significantly strengthened. This means that insurers will essentially be subject to two supervisors as soon as the PA goes live and will be subject to two sets of law, prudential and separate market conduct standards.
The FSR Act also makes consequential amendments to all sectoral laws to align them with the market conduct approach and empowers the FSCA to draft standards for conduct in addition to its market conduct rule-making powers under existing sector specific laws or where no such specific sectoral market conduct law exists such as for Banking. So, after the FSCA goes live all institutions currently regulated by the FSB will still be subject to the same sectoral laws, as amended by the FSR Act, as well as potential new conduct standards that may be developed under the FSR Act. The FSR Act will therefore operate as an “overlay” over the existing sectoral laws. This status quo will remain until such time that the Conduct of Financial Institutions Act (COFI) is in place and all current licenses are converted to a market conduct license.
From a market conduct perspective, COFI will be a risk based and proportionate piece of market conduct law. This means that when the FSCA sets conduct standards under COFI, it will take into consideration the regulatory and compliance burden on small institutions which do not pose significant risk to customers, while at the same time ensuring that those institutions which do pose significant risk are subject to more intrusive supervision. This should provide some alleviation for small organisations with regard to regulatory complexity but not from their duty to treat customers fairly. The Treating Customers Fairly (TCF) principles will be embedded into the COFI law and the FSCA’s approach will require that financial institutions are able to demonstrate delivery of fair outcomes for financial customers, rather than just ticking a compliance box.
1.2 Cost implications
While implementing the Twin Peaks model will have cost implications, Da Silva believes that from a market conduct perspective these costs will be appropriate compared to the size of the financial sector’s assets and revenues. The extension of the jurisdiction of the FSCA to all financial institutions including banking, and aspects of the conduct of certain credit providers, means that these institutions will pick up the appropriate portion of these additional costs where resourcing is required to enable their supervision. Over and above the extension of jurisdiction, the proactive, risk-based and outcomes-focused approach to regulation and supervision under Twin Peaks will require some different skills at the FSCA which implies additional costs. These include strong research skills, data analytic capability, Fintech capability and the use of Fintech to supervise and regulate just as a few examples. These initial costs however should be justified over time by greater efficiencies and embedment of appropriate risk based supervision, which for many will result in an alleviation of costs but not responsibility.
2. Understanding the FSR Act
The President of South Africa recently signed the Financial Sector Regulation (FSR) Act into law. This Act is largely seen as being the backbone to the Twin Peaks regulatory system.
The objective of the Act is to split the regulating authorities of the financial services sector into two centres. The first centre will be a Prudential Authority (PA), which will fall within the Reserve Bank and will supervise the safety and soundness of financial institutions. It will be headed by the Governor of the Reserve Bank, and overseen by a committee that includes the Governor.
The second centre will be the Financial Sector Conduct Authority (FSCA), which will replace the FSB, and will supervise the manner in which financial institutions conduct business and treat their customers. The FSCA will be a standalone institution, managed by an executive committee that includes a commissioner and deputy commissioners, with independent governance committees for issues such as remuneration, audit and risk.
The Banking Association of South Africa (BASA) is pleased that the Act will align South African financial sector legislation with global best practice.
“This sophisticated piece of legislation brings South Africa in line with — and in some instances beyond — prudential and market conduct reforms around the world. The new law will add to South Africa’s already sound financial market and banking regulatory framework,” the BASA said.
Law firm Cliffe Dekker Hofmeyr said in a statement that the new regulatory framework aims to address the fragmented nature of the current regulatory framework. It will ultimately contribute to broader economic strategies for increased job creation and inclusive growth through maintaining stability, protecting from the substantial costs associated with systemic risk, improving access to good quality financial products and services, whilst supporting the efficient channelling of savings into investment, in order to attain a stable environment for doing business in South Africa.
Rosemary Lightbody, Senior Policy Advisor at the Association for Savings and Investment South Africa (ASISA), says ASISA and its members fully support the strengthening of the financial sector through the introduction of appropriate structures for more efficient regulation, supervision and oversight.
Compli-Serve SA managing director Richard Rattue says the whole point of the Twin Peaks model is to create a more robust financial system and strengthen oversight of market conduct. “It is a more direct approach to consumer protection and market conduct across financial services,” he said.
3. The Twin Peaks model is set to shift the approach to licencing
According to the FSB – which will change to the Financial Sector Conduct Authority (FSCA) under the new Twin Peaks financial regulatory model – there is going to be a shift from the current sectoral licensing model to a more centralised, activity-based licensing model.
This shift, however, will only take place in the second phase of implementation of the Twin Peaks model. Until then, the regulator says, the licensing of entities will continue to take place under the existing financial sector laws. Towards an activity-based licensing model.
In the second phase of Twin Peaks implementation, the proposed (C0FI) Bill, which is currently being drafted, will provide the framework for licensing based on activities.
According to the current proposals, financial institutions will, in the second phase, be required to apply for a licence from the FSCA to render a financial service in respect of specific, defined activities they perform – as opposed to under different sectoral laws. The COFI Bill will define all of these activities in a single, overarching law.
All new applicants, irrespective of their size and complexity of business (from small financial advice practices to large financial services groups), will be subjected to a thorough licensing process.
Licensing is a critical component in the regulatory framework and serves a key function in the supervision value chain. It facilitates and provides an entry point for all applicants before they are allowed to conduct any business. It is therefore essential that licensing systems are not only efficient but also robust.
It is important to note that the principle of proportionality will apply, to ensure that there is no “one-size-fits-all” licensing approach. Instead, the approach and requirements will be proportionate to the risks underlying the businesses activities of different entities. According to the supervisor, this will ensure that the licensing requirements do not pose any unnecessary barriers to entry into the financial services sector.
3.1 A more collaborative approach
In instances where licence applications are under the supervision of multiple regulatory authorities, the FSCA will enter into Memoranda of Understanding (MOUs) with the other authorities, such as the Prudential Authority (PA) and the National Credit Regulator (NCR). These MOUs will govern the relationships, cooperation and obligations between the different authorities.
As an example: The NCR remains responsible for licences issued under the National Credit Act. In the first phase of Twin Peaks implementation, the PA will be the licensing authority for Banks and Insurers The FSCA will be the licensing authority under the other financial sector laws. In the second phase of Twin Peaks implementation, certain entities will need to be licensed by both the FSCA and the PA, under their respective laws.
The MOUs between the authorities will ensure that this process is streamlined and co-ordinated.
3.2 A more trusted and stable financial system
The new licensing framework is designed to support the objective of the Financial Sector Regulation (FSR) Act, which is to: Achieve a stable financial system that works in the interests of financial customers and supports balanced and sustainable economic growth in the Republic. It does this by establishing – in conjunction with the specific financial sector laws – a regulatory and supervisory framework that promotes:
- Financial stability;
- The safety and soundness of financial institutions;
- The fair treatment and protection of financial customers;
- The efficiency and integrity of the financial system;
- The prevention of financial crime;
- Financial inclusion;
- Transformation of the financial sector; and
- Confidence in the financial system.
The process for phasing in the final Twin Peaks licensing framework is expected to be set out in the draft COFI Bill and supporting National Treasury explanatory documents, which will be published for comment in the next few months. It is important to note that existing licences will be mapped to the new activity framework and converted to the Conduct licence to ensure continuity of business.
4. Enforcement under Twin Peaks: What will it look like?
In the past, critics have complained that regulators have not been able to adequately reign in or punish law breakers. In cases where they have been able to, the process has taken too long.
Different regulatory authorities have previously approached enforcement in varied ways, driven by the legislative frameworks in which they operate. Competition law enforcement, for example, could be described as an external enforcement system. In that system, the Competition Commission does investigative work and then refers the matter to the Competition Tribunal for a decision.
The South African Revenue Service (SARS), on the other hand, follows an internal enforcement model. SARS determines any penalties to be paid for non-compliance, and levies them.
To date, the FSB has followed a hybrid internal/ external enforcement model. In instances where the FSB finds that a penalty is the appropriate sanction, it refers the decisions to the Enforcement Committee. Although this Committee is made up of external, objective experts, it is still “inside” the FSB, in the sense that it reports to the Board of the FSB, and so has no independent legal personality.
The Twin Peaks model will follow a similar hybrid approach, while introducing new instruments to give regulatory more room to apprehend transgressors.
4.1 Enforcement under Twin Peaks
Although the Financial Sector Conduct Authority (FSCA) follows an internal enforcement model, it has also established the Financial Services Tribunal, which fulfils the role of independent arbiter to challenge administrative actions (i.e. actions that are taken internally by the authorities in terms of the legislation, regulations and rules).
While the authorities may take an administrative action on their own, all administrative actions can be appealed to the Tribunal and reviewed by the courts.
If the future PA or FSCA detects a breach of a financial sector law – including breaches of a prudential or conduct standard – it faces a range of decisions.
The authority can impose administrative penalties, or institute criminal prosecutions in relation to the offences in terms of the Financial Sector Regulation (FSR) Act or a financial sector law.
Alternatively, the authority can choose to remedy the situation, either by issuing directives, declaring practices as undesirable, applying to the court for appropriate orders, or entering into Enforceable Undertakings. The aim of this remediation is to rectify the breach and ensure it does not recur.
4.2 Enforceable Undertakings
Although they have only been introduced into the Financial Services Board Act recently – and are also provided for in the FSR Act – Enforceable Undertakings are a new instrument most sectors can use.
An Enforceable Undertaking provides the authority with broad remedial powers under an agreement with those who break the law. Enforceable Undertakings typically involve a number of detailed steps, which the transgressor contractually commits to follow to correct a flaw in a process or system used by the financial institution, and/or pay compensation to affected customers.
In the event that a financial institution fails to meet the agreed terms of the Enforceable Undertakings, the authority may:
- Impose an administrative penalty;
- Apply to a court for an order directing that person to comply with the terms of the Enforceable Undertakings, or any other order the court considers appropriate;
- In the case of a licensed financial institution, suspend or withdraw the licence.
Details of an Enforceable Undertaking are generally made public, in an effort to deter other transgressors.
The FSCA may institute proceedings in the High Court, compelling a financial institution to:
- Comply with a financial sector law;
- Cease contravening a financial sector law;
- Comply with a lawful request, directive or instruction made, issued or given by the authority in terms of a financial sector law;
- Obtain a declaratory order relating to any financial sector law or the business of a financial institution;
- Prevent the concealment, removal, dissipation or destruction of assets or evidence by a financial institution;
- Seize and remove the assets of a financial institution for safe custody, pending the exercising of any other legal remedy that may be available to the authority.
4.3 Debarment Orders
Authorities can use Debarment Orders when they wish to protect certain groups; or financial customers generally, from certain individuals. The authority must first determine that a person has:
- Contravened a financial sector law, a regulator’s directive or an Enforceable Undertakings;
- Attempted, conspired with or aided, abetted, induced, incited, instigated, instructed or commanded, counselled or procured another person to contravene a financial sector law;
- Contravened or failed to comply with a law of a foreign country that corresponds to a financial sector law.
The authority may then make an order debarring the person for a specified period from:
- Providing financial products or services, providing a specified category or sub-category of financial product or service, or providing a financial product or service to a specified category or sub-category of financial customer;
- Acting as a key person or representative of a financial institution;
- Being involved in managing a financial product or service provider;
- Being involved in providing a specified financial product or service.
If the authority is satisfied that a person has contravened, or has failed to comply with, a provision of a financial sector law, the authority may impose an administrative penalty in respect of the contravention.