Financial regulation in South Africa (I)
4 July 2019
After a review of South Africa’s financial regulation that began in 2007, reforms were initiated in 2011 following the publication of a policy paper entitled “A Safer Financial Sector to Serve South Africa Better.” Central to this was the move towards a financial regulation regime called Twin Peaks, which came into full effect on 1 April 2019.
HISTORY OF TWIN PEAKS
Named after the 1990 US mystery horror television series, Twin Peaks was developed in 1995 by Dr Michael Taylor – Principal Lecturer in Financial Services Regulation at the London Guildhall University. In his seminal paper, The Barings Crisis: Some Lessons for the Management of Trading Risks in Financial Intermediaries, Taylor unpacked the failings in the regulation of UK banks and financial markets. Regulation was sectoral, whereby banks were regulated separately from other financial institutions, such as insurers.
Taylor argued that sectoral regulation was not fit for purpose because financial firms were no longer clearly delineated along different sectors; such as banks, insurers and stockbrokers. Taylor pointed at that when single firms began to participate in more than one sector, regulators whose authority was divided along these different sectors, began to face problems. However, his suggested Twin Peaks model was rejected in favour of a mega-regulator which brought all financial sector firms under one umbrella – which the IMF also touted as the superior model. Then the crisis of 2008 happened.
Following the collapse of Northern Rock, an inquiry by British Parliament identified massive shortcomings in the regulator, the Financial Services Authority – that the tension between prudential regulation and protecting customers is frequently incompatible. When a single regulator is faced with the choice of helping thousands of aggrieved consumers or avoiding a financial crisis, most regulators would choose avoiding a financial crisis, leaving consumers unprotected. A poor outcome from a policy perspective.
The 2008 financial crisis also showed how market misconduct and consumer abuse on a large scale, as happened with sub-prime loans, can also become a source of financial crisis. And the near collapse of US insurer AIG in 2008 showed how insurers too are systematically important, because prior to this it was assumed that only banks carried systematic risk.1 As a consequence, the Twin Peaks Model has now been adopted by Australia, the Netherlands, New Zealand and the United Kingdom.
OVERVIEW OF SOUTH AFRICA’S TWIN PEAKS
The legislation implementing the new model in South Africa is the Financial Sector Regulation Act, tabled in Parliament in October 2015 and enacted in August 2017. The new regulatory model does away with the notion of multiple regulators: one each for banks, insurers and medical aid schemes.2Transitional arrangements were adopted for the establishment of the two Twin Peaks regulators,3 with the Prudential Authority (PA) being established on 1 April 2018, and the Financial Sector Conduct Authority (FSCA) a year later on 1 April 2019.
The PA is vested in the South African Reserve Bank (SARB) and is responsible for the prudential regulation and supervision of financial conglomerates, banks, insurers, corporate banks, co-operative financial institutions and certain financial market infrastructures. The role of the PA is to ensure the soundness of these institutions and infrastructures in order to maintain financial stability. The CEO of the PA is the SARB Deputy Governor.
The FSCA, which replaced the Financial Services Board (FSB), is responsible for regulating and supervising the conduct of financial institutions. Its roles are consumer protection and to ensure that the financial system is not distorted through market misconduct. The FSCA is headed by a Commissioner appointed by the Minister of Finance.4
The PA and FSCA have the power to create regulatory standards, and alongside them sit four other authorities which are collectively responsible for South Africa’s financial regulation:
- SARB – now with new financial stability powers and continues with its mandates for monetary policy, payment system oversight and foreign exchange transactions oversight;
- National Credit Regulator (NCR) – established in 2005 and continues overseeing the conduct of credit providers.
- Financial Intelligence Centre (FIC) – established in 2001 to fight money laundering, whose primary role is to protect the integrity of the financial system; and
- Ombuds – which operate under the Financial Services Ombud Schemes Act of 2004 and might amalgamate into a single financial dispute resolution system.5
The following councils and committees have also been set up in order to facilitate effective co-operation between the different regulatory bodies:
- Financial Services Tribunal (FST) – ensures that the internal policies and enforcement procedures are clear, that there’s transparency and accountability, as well as efficient appeals mechanisms.
- Financial Stability Oversight Committee (FSOC) – facilitates cooperation between SARB and the regulators (PA, FSCA, NCR and FIC) in matters concerning financial stability. It will also advise SARB and the Finance Minister on the designation of Systematically Important Financial Institutions and matters relating to crisis prevention and management.
- Financial System Council of Regulators (FSCR) – facilitates cooperation between the Director Generals, CEOs and Commissioners of the various financial regulatory bodies.
- Financial Sector Inter-ministerial Council (FSIC) – promote cooperation between cabinet ministers responsible for financial sector regulation, namely the Minister of Finance, the Cabinet member responsible for consumer credit matters and the Minister of Economic Development.
POTENTIAL BENEFITS AND DRAWBACKS
The Twin Peaks model is thought to have the following advantages:
The objectives and mandates of the two peak regulators are likely to be more clearly defined.
It is less likely that one aspect of regulation will dominate, and the regulatory culture will be able to develop depending on the regulator’s function.
The model may be better adapted to the growing complexity of financial markets and the rise of financial conglomerates.
It will better avoid the conflicts of interest that arise from having a single regulator.
With regards to possible disadvantages:
Twin Peaks may create regulatory overlaps, which if not carefully managed could place a considerable burden upon regulated entities, leading to poor information sharing and poor cooperation.
If the cooperation between regulators is insufficient, this will have potentially serious consequences.6
With the formation of a large number of new councils and committees, an increase in the cost of compliance for regulated entities will likely be passed onto the consumer, and also raise the barrier of entry to the financial sector.
South Africa is the first emerging market country to adopt Twin Peaks. Some argue that this was necessary because it is fit for both the present and the future given the country’s highly advanced and sophisticated financial services sector.7 On the other hand, there are those who argue that South Africa’s regulations were already fit for purpose,8 with South Africa having avoided the direct consequences of the 2008 financial crisis, thanks to exchange controls which prevented banks from participating in the more perverse derivative instruments available internationally, as well as the local banks being more conservatively capitalised and tightly regulated when compared to much of the rest of the world.9
Whether the adoption of Twin Peaks locally was necessary or not, industry and law experts warn that, given the potential overlaps and high levels of cooperation required amongst the different regulatory bodies, it will have the potentially serious detrimental consequences if this complicated financial regulation regime is not properly managed.10
Charles Collocott, Policy Researcher, HSF, 4 July 2019
3 Andrew Godwin (2017) Introduction to special issue – the twin peaks model of financial regulation and reform in South Africa, Law and Financial Markets Review, 11:4, 151-153, DOI: 10.1080/17521440.2017.1447777.
5 Op cit note 4.
6 Op cit note 4.
7 Op cit note 1.
10 Op cit note 4.