Financial Sector Regulation Bill: costing & transformation; Insurance Bill: initial briefing

Meeting report

The Chairperson commented that a key issue for this Bill was the fees and levies, and it was, in effect, a Money Bill.

Funding Considerations for Financial Sector Regulation Bill
Mr Roy Havemann, Chief Director of Finance and Markets at the Financial Services Board (FSB), said the reason governments regulate is because the costs of failure are great. The costs of the financial crisis in 2008 went into trillions of pounds.

The Chairperson said that National Treasury’s point was that even if it cost a lot to regulate, it would cost a lot more if there was no regulation.

Mr Havemann said that the expected cost of regulation in 2016/17 is R1.033 billion and a somewhat ‘cheeky’ comparison would be that the combined remuneration packages of directors and senior executives in the largest financial sector firms was R1.243 billion in 2015.

According to South African Reserve Bank (SARB) figures, the financial sector contributed about R325 billion to the economy in 2015. So, the total direct and indirect costs would amount to approximately 1.3 to 1.8% of this contribution.

Mr Unathi Kamlana, Deputy Registrar of Banks: South African Reserve Bank, said SARB’s Banking Supervision Department (SARB: BSD) totaled R201 million, with R133m for personnel and R68m for operations. As the Prudential Authority (PA) is taking over the insurance prudential function from the Financial Services Board (FSB), the estimated budget for 2016/17 would be R98 million, of which R44 million is for the 55 people migrating to SARB and R54 million is for operations.

Mr Kamlana said the PA’s estimates going forward estimate the cost to be R378 million in the first year. As the PA is located within SARB there are indirect costs, including office space and IT, which are catered for by the broader SARB budget. The indirect costs do not form part of the R378 million.

Mr Kamlana said SARB has prescribed charges through the Banks Act and its regulations. An example is the annual licence fee which has a minimum of R6 000 and maximum of R300 000. The other types of fees are for specific services performed by SARB: BSD. These include considering an application for an amalgamation or merger or acquisition, which could cost up to R40 000 for the hours and labour put into that consideration. Fees are charged for inspections and other functions.

Mr Kamlana said the approach to setting fees considers factors including the international standards regarding the capital requirements to establish and maintain the bank, linked to risks in the bank. For annual licence fees, the determination is based on a formula prescribed by regulations which uses total capital and liabilities. For specific services, the cost to SARB: BSD in order to complete the task is the guiding factor.

Mr Kamlana said the range of institutions regulated by SARB: BSD starts with stokvels regulated under an exemption from the Banks Act by National Stokvel Association of South Africa (NASASA), cooperative financial institutions which are regulated by the Co-operative Banks Development Agency (CBDA). Cooperative banks, mutual banks and normal commercial banks are regulated directly by SARB: BSD.

Mr Kamlana said that, going forward, the PA is proposing a cost recovery mechanism for fees relating to the liabilities of a particular financial institution. The intention is to have all financial institutions contribute to the total cost of the PA, proportionally linked to the size of the particular institution. The size being determined by the liability structure of the institution. Perhaps a minimum fee could be considered of R100 000 and having a cap of R50 million. If there is no cap, it is estimated that the five largest banks would be paying around R73 million.

Mr Ismail Momoniat, Deputy Director General: Tax and Financial Sector Policy Treasury, said this would constitute the prudential fee.

Mr Jonathan Dixon, Head of Department: Insurance Compliance FSB, said the current FSB budget is R744 million, with personnel at R451 million and operational costs at R293 million.

The estimated budget for the future Financial Sector Conduct Authority (FSCA) is slightly more complicated than for the Prudential Authority. The PA will become a new department within SARB meaning that there is an existing organisation with leadership, that can make decisions around the structure of the new authority.

With the FSCA there will be a completely new organisation and the new leadership will have to determine what the organisational structure will look like. He added that there can be no assumption that the current FSB leadership will be the FSCA leadership, given the Bill’s appointment processes. The FSB can only do preparatory work to present as recommendations to the future leadership.

Mr Dixon said a rough estimate has been made of how much it could cost to perform the new functions given to the FSCA under the Bill. Taking the current budget and removing the insurance prudential supervision function which is shifting to the PA the baseline comes to R646 million. The new functions costs are estimated based on the number of staff expected to be required, assumed to be 60% of the total cost, with the remaining being operational costs.

Highlights of the estimated costs of new functions included banking conduct supervision which no other regulator was currently doing, meaning this would be an entirely new function, costing around R20 million. Specialist supervisory support is a function which was part of the Bill’s push towards having an outcomes driven, proactive regulation requiring specialist knowledge of business models and products. This technical support would have to be added to the FSCA at an estimated cost of R50 million. Expanded financial market supervision will deal with aspects not presently covered by the Financial Markets Act, which will need to be added going forward. Examples would be the introduction of additional security exchanges and over the counter derivative exchanges. This is estimated to cost R20 million.

These are examples of the on-going costs which will arise from the FSRB, but there will be once-off costs, such as the setting up of IT infrastructure and branding.

Mr Dixon said the FSB already has a proportionate approach to fees. The first criterion looked at in setting fees is the base amount, which recognises that regardless of the size of the institution there is a minimum amount of time and effort expended in regulating any entity. Above that a variable amount is applied which is proportionate to the nature, size and complexity of the regulated entity. There is a special dispensation aimed at supporting financial inclusion and transformation, by having lower fees for institutions focusing on the low income sector. The future approach will continue to be proportionate and the costs will be carried by entities newly subject to regulation and larger, more complex entities which pose a higher risk to the achievement of the supervisory objectives. The intention, though, is not to impose those higher costs on entities which are supporting the transformation and inclusion objectives of the regulator.

Mr Dixon said that the main change will only affect banks. In addition to banks paying their fees to PA, they will now pay a fee to the FSCA to the cover the costs of the supervision of their conduct. The other change envisaged is in the financial markets infrastructure space where up until now there has only been one exchange, the Johannesburg Stock Exchange (JSE), which has been charged a flat fee. With the new approach, there will be a base fee plus a variable amount. The variable amount is proposed to be in proportion to the number of transactions and trades on the exchange.

Mr Momoniat added that these are just the initial estimates of the budget and that in reality, the budget will depend on what is prioritised. If you take market conduct of banks, which is inherently a large problem, then there will need to a proportionally sized regulatory strategy which will obviously have an impact on the budget. He said the important thing to focus on is the process, it is necessary that it is as transparent as the budget process.

Mr Momoniat said that there needs to be oversight, but that brings into question what the appropriate oversight entails. He said that strategy and sources of funding will be published but asked what the role and levels of remuneration will be. Remuneration will become important. In some jurisdictions such as Hong Kong, regulatory bodies ensure that their highest salary can match that of the top CEOs of the institutions that they regulate. This is an example of a policy decision that a stance has been taken on and implemented.

Mr Momoniat said that it is necessary to differentiate between the cost rate to holding a licensee where there is an annual fee and certain reserve requirements. When it comes to other activities such as the need to step up consumer education, tribunal and ombuds councils, these costs need to be considered in the budgeting. These extras may be more suited to a levy. Looking at the entire approach it is the regulated institutions who are funding the operations and not ordinary taxpayers. There is a redrafted Chapter 16 which will be brought back in October after some issues have been clarified. This will outline fee processes and structures.

Mr Momoniat said that the socio-economic impact assessment can be spoken to but whenever there is going to be any levy or a levy increase, there is going to be a discussion where people will have diametrically opposed views. Just as the way we deal with the tax process, we would hope to radically improve the process in the way in which we do the budget. We want to put out a document at the beginning of the financial year for consultation. At the end of the day, a lot of this cannot be determined up front because some things will be revealed and identified as needing tending to as we evaluate.

Pensions funds, for instance, are relatively lightly regulated currently. With Twin Peaks, we want it to be regulated prudentially and regulated for market conduct. Down the line, there might be other issues that come up, including perhaps a Bill on deposit insurance.

Discussion
Ms Rosemary Lightbody, Senior Policy Advisor: Association for Savings and Investments South Africa (ASISA), agreed with Mr Momoniat that it is difficult to estimate exactly what the costs will be at this stage. Given that the FSR Bill is an enabling framework, it is only once the standards provided for are published that a full assessment can be made. The Industry did make submissions on the costs for the research that was commissioned by the Treasury for the impact assessment. Those collated figures have not yet been received but are understood to have been submitted directly to Treasury.

Ms Lightbody conceded that costs do have to be borne by someone, ultimately, which in the case of financial services tends to be either the client or shareholders. She said that the industry does not have a nonchalant response about the client bearing costs. It is a highly competitive industry, especially with the comparative measures that are being introduced by ASISA with effect in early October.

Ms Lightbody said that ASISA believes that the improved transparency and cost comparison will increase that competitiveness because it will be much easier for customers to compare costs from product to product. To remain competitive, service providers cannot just load this onto the customer. So then one looks to the shareholders but, of course, if shareholders are going to be severely compromised, then that falls to the pension funds and by and large the shares. It is thus understood as a balance. ASISA hopes the increased supervision will detect undesirable market conduct and to detect systemic events. She said that this is a welcomed improvement which the Industry foresees and accepts will come with costs.

Ms Lightbody said that ASISA is particularly interested in the sort of measures of effectiveness that would be put in place to evaluate the outcomes, especially since there is a cost attached to the implementation of the regulatory framework. She said that it would only be worthwhile if there were mechanisms to establish what works and what does not.

Ms P Kekana (ANC) indicated that it is necessary to try and incorporate the prescripts of transformation to ensure that those who were not previously able to participate in the financial sector are able to finally do so.

Ms Kekana appreciated the significance attached to the protection of clients in the activities of the financial services sector. She said funeral undertaking, for example, is a huge industry in the black community but that they are not able to play in the bigger playing field of the economy and wanted to know how this could be made possible.

Ms Kekana said that the focus of the presentation was more on what the prudential issues could be and what the market conduct could be. She says that on the excursion, it was mentioned that it may not be Twin Peaks but rather ‘three or four peaks’. Therefore, the presentation does not speak to her.

The Chairperson said that the same grounds keep coming up and he would appreciate briefness. He said that it is not necessary to exhaust the entire document, consisting of many pages, in this meeting and urged Members to read it in their own time. In the meantime, he requested a summary from FSB.

Mr Havemann, referred to the summary in Table 4 of the presentation, saying that they tried to combine both direct costs and indirect costs of supervision under the current regulatory framework. Currently, the combined costs of the FSB and Reserve Bank are just under a R1 billion which is about 0.27% of the gross value add of financial corporations. This is rather a small number in the greater scheme of the banking system. The indirect cost of compliance functions is, in contrast, reasonably large and is the impact on financial institutions in complying with the necessary laws. The current total cost of the system of financial regulation is around R4,1 billion and estimated, with inflation, to be around R4,4 billion in 2016/17.

Mr Havemann said that looking at all the different scenarios of cost implications and cost increases as a result of Twin Peaks, it will probably cost in the order of R4,5 billion to, in the worst case scenario with an overall cost increase of 50%, a total of R6,2 billion. Costs will only probably rise by 10% so the total impact will be costs of around R5 billion. In comparison to the total budget for the country which is R1,1 trillion, Treasury alone costing R1,2 billion, the R5 billion for financial regulation is comparably reasonable.

The Chairperson questioned the credibility of the figures presented. He said that this Committee does not have the capacity to evaluate the credibility of what has been presented to them. The final concern for Members is how this will impact on the customer and that this has never really been answered. It would be welcomed if there were some regulatory mechanisms or provisions that restrict the capacity of the financial institution in increasing the costs for the customer.

Mr Momoniat replied that any socio-economic study depends on assumptions. It is very much like forecasting but that does not render it useless. It gives one a feel and in later years can be used as an instrument for evaluation. A lot of the architecture for this legislation came from the Red Book and in the context of the 2008 financial crisis.

Mr Momoniat said that they are setting up a market regulator which speaks precisely to customer protection. The biggest rationale for this Bill is to attain financial stability at a macro level and to ensure that customers are dealt with fairly.

Mr Dumisani Jantjies, Deputy Director: Finance for the Parliamentary Budget Office (PBO), said that the protection of customers is very important. The role of the Ombudsman is a significant one because it is a very strong consumer protection body. He asked what degree of importance has been given to the Ombudsman.

Mr D Maynier (DA) asked if it was wise to implement such a Bill on the brink of a recession when the effect of the Bill will, essentially, be an additional tax on business.

Mr Momoniat replied to Mr Maynier, that the crucial thing will be the annual rounds. They have been mindful of the impact on stakeholders. The basic regulation has to go and in the formulation of this Bill the participation process is exactly for the purpose of getting input from those who will be affected by its enactment.

The Chairperson said that the next issue is constitutionality. From his understanding all the constitutionality matters have been dealt with and resolved. He confirmed this with the Members. He asked, especially, Mr Maynier, whether any constitutional issues had come to the fore. 

Mr Maynier responded by saying that at this time there were no constitutional issued to be raised but that there is a possibility of such after legal consultation.

The Chairperson remarked that people go the Constitutional Court to raise issues for political reasons and to seem radical. if any Member has any issue with regard to the constitutionality of the Bill, it should be raised in the Committee meeting first.

Transformation in the Financial Sector
Mr Momoniat said that he has gotten the sense that financial inclusion is very topical and especially so to the Committee. When one looks at transformation, there are many aspects to it. The financial sector as whole is a key enabler to attaining sustainable economic empowerment and development. Financial inclusion is a very important objective which is essentially to get more participation from ordinary persons, previously disadvantaged individuals and black owned businesses in the economy.

Mr Momoniat said that one of the first forms of transformation was realised in 2003 through market structure. The Financial Sector Code governing this precedes BBBEE but only took effect around 2008. The deliberation process started in 2001.

This legislation has number of objectives but that the main ones ought to be highlighted and the whole issue of consumer education is particularly important.

Ms T Tobias (ANC) said that first, the perceptions of ownership and control needs to change in South Africa. She warned that the change is going to be radical. The manner of transformation is not effective. People are placed in the street to pick up litter and this is labelled as job creation but it is actually not; people do not want to remain low ranking. There needs to be radical policy to change these policies that are locking people out. The introduction of the Post Bank is not enough to give effect to financial inclusion.

Ms Tobias said the licence fee is not the actual problem because it is not a particularly high fee. What is problematic is the threshold minimum amount that one needs to have to qualify; this is limiting. People need to be empowered and competent. There has to be a black owned bank somewhere in the near future, that will be an actual step toward in transformation.

Mr Kamlana said that banks, given their special role, have to be prudentially sound for the protection of the the ordinary person and not, as it may seem, for the sake of the regulated institution. It is not that we want fewer banks but rather to foster order and stability in the financial sector. There are a number of considerations that go into the licensing of banks. So it is not that no one wants black owned banks, the policy considerations that go into financing and licensing of banks are quite onerous and not easily passed.

Ms Tobias said that education and awareness is the real challenge. People can mobilise the funds but here we are talking about giving previously uninvolved people an opportunity to play in the banking field.

Mr Lyndwill Clarke, Head of Consumer Education at FSB, said that one of the FSB mandates is consumer education. Most of the implementation has gone into projects but FSB has been lacking in capacity. FSB tries as far as possible to provide information to consumers so that they are enabled to make informed decisions. They look at appropriate content for appropriate target groups. Since the primary challenge is capacity, the FSB works with the Department of Public Works through their Extended Public Works Programme to reach beneficiaries. Going forward, there is a shift toward becoming a thought leader more than an implementer, creating standards and guidelines for use by industry and stakeholders.

The Chairperson requested that a summary on consumer education be provided to the Committee and that the conduct authority is present at the next sitting. He requested the conduct authority meet with the Committee at least four times a year. What is emerging is more a programme of action for the Committee than anything else.

Mr B Topham (DA) requested a report from the Reserve Bank with actual figures indicating transformation rates in certain financial sectors. It is necessary to classify the holdings in terms of race to monitor transformation and so compare the figures of the past with the present to determine whether transformation is being effected.

The Chairperson said that transformation is not just about racial demographics but fundamental shifts in power relations. The Chairperson proposed that before the next State of the Nation (SONA) debate, there be a whole day sitting by the Committee on transformation in the financial sector.

Insurance Bill
The Chairperson said that another meeting will be reserved for a more in depth deliberation on the insurance legislation. He asked that the briefing on this bill be brief.

Mr Jonathan Dixon, Head of Department: Insurance Compliance FSB, said that South Africa currently has a Long Term Insurance Act and a Short Term Insurance Act which is a combination of conduct and prudential provisions. This is being split and all the prudential provisions will be contained in a new and combined Insurance Act. On the conduct side there will be Phase One which is a temporary Long Term Insurance Act and Short Term Insurance with only conduct provisions until Phase Two which will see them combined into a single Act.

The Bill builds on the Twin Peaks model of regulation and the objectives of the FSRB. It does so by:
• promoting inclusion and transformation by the introduction of a micro insurance regulatory framework which has actually been in the pipeline.
• ensuring the safety and soundness of insurers through the introduction of a prudential regime called the Solvency, Assessment and Management (SAM) which is the insurance equivalent of Basel III in the banking sector, Solvency 2 in the UK and other prudential regimes.
• contributing to financial stability by introducing a framework for insurance groups supervision; and
• compliance with international standards in accordance with our commitments.

The inclusion and transformation aspect gives effect to Treasury’s micro insurance policy document which was released in July 2011. It helps the formalisation of current informal providers. It aims to lower barriers to entry to encourage broader participation by way of lowering capital requirements and having a simpler prudential regime while, at the same time, having proportionate conduct standards to protect policy holders.

SAM is about introducing a forward looking risk based approach to solvency in the insurance sector where capital requirements are aligned with the underlying risks of the insurer. It has three pillars like Basel so it consists of the quantitative capital side, the governance side and the reporting requirements aspect. It is essentially about bringing insurers into a more sophisticated sphere of risk management and introducing more effective risk management tools.

With regards to insurance groups supervision, this aspect recognises that lots of insurers are actually part of broader financial services groups and insurance groups. As supervisors we need to look at risks within the group as a whole. Things like intergroup loans and intergroup exposures can expose policy holders to risks. Given the integrated and interconnected nature of the South African system, it is necessary that we look at risks of insurance groups on a consolidated basis. This is instead of the current system that just looks at the soundness of each individual insurer.

The international standards for insurance are set by the International Association of Insurance Supervisors (IAIS) which is the equivalent of the Basel Committee for Bank Supervisors and the International Organisation of Securities Commissions (IOSCO). It has 27 insurance core principles (ICP) against which we have been assessed. We fell short of these ICPs but this will be remedied by SAM.

The SAM provisions have gone through an extensive consultative process. SAM has been in the pipeline for the past seven years in which there has been more than 117 discussion documents and position papers on the various components of the framework, all of which have gone through at least three rounds of consultation. There have been three quantitative impact studies to test the capital proposals as well as an economic impact study and a socio-economic impact assessment.

This is a big change for the insurance industry so there has been a pilot test from July 2014 and from the beginning of last year a comprehensive parallel run to determine implementation readiness.

Similar to the FSRB, it constitutes the framework legislation. It is much shorter than the FSRB. All the technical figures are contained underneath in the Bill and will need to comply with the FSRB.

Discussion
The Chairperson said that they did not have copies of the presentation and that he would prefer getting a copy only once it has been improved on and reviewed. He asked for a response from ASISA.

Ms Lightbody said that their members are anxious to have certainty sooner rather than later. Once everything is bedded down and the basic things like who should be contacted in respect of what issues will be clearer and people will feel more comfortable about the new structure.

Ms Lightbody, responding to whether or not implementation is feasible, said that it all depends on when drafts are published. It is feasible but it depends when the process of consultation and publication starts. A feasible timeline is important, considering everything else that is coming from other regulators at the same time. The tabling of the Conduct of Financial Institutions (CoFI) Bill in the first quarter of 2017 is a bit optimistic, but it would be welcomed, if it was completed sooner than later.

The Chairperson said that, if they are lucky, the deliberations on the Bill will be completed by the Committee timeously but that the NCOP will probably not have time to consider it until next year.

Ms Kekana asked whether or not the British model of Twin Peaks was going to be considered as it is and brought into the South African context.

Ms Tobias said that the decisions will not affect stakeholders so much because there will not be any significant changes to the way they are required to report. Her worry, more than anything else, is the financial implications. She questioned if it would be feasible and if it will be possible to implement without affecting the performance of the authorities. She took it for granted that the National Credit Regulator (NCR) was going to combine with Financial Services Conduct Authority (FSCA).

Mr Chairperson noted that at the subcommittee meeting the following day, he would only be available until 12h30 after which he would be in attendance intermittently. Mr Topham had been nominated by the DA to attend.

Mr Maynier interjected saying that they had been informed that the subcommittee would be meeting in Johannesburg and that it was on that basis that Mr Topham was nominated as representative. Now at a moment’s notice, the meeting has been moved to Cape Town despite Mr Topham leaving for Johannesburg in the next thirty minutes.

The Chairperson told Mr Maynier that this is not his problem; to which Mr Maynier replied that the DA would not have a representative present at the meeting. The Chairperson said that the Committee will not humour people that do not read the documents and that are constantly busy with their cell phones. He asserted that he has nothing to be apologetic about.

The Chairperson said that Mr Maynier was absent at a previous meeting and that Mr Maynier thinks that if he is not present at a meeting, the Committee cannot proceed with the matter. The Chairperson said that they are not prepared to entertain this for anyone.

Ms Tobias added that it is unfair that Mr Maynier had not come forward on matters relating to content. Mr Maynier did not even ask Mr Topham if he was prepared to attend the following day’s meeting.

The Chairperson said that this was nothing new. He asked that the Committee continue with the meeting.

The Chairperson said that even the NCR representative said that the Financial Sector Regulation Bill does not represent them. From his knowledge, the Financial Services Board had already met with the NCR.

The Chairperson added that the DA has an ideological problem which has been their constant position. Nothing is going to change this problem and that they will always find a way to put this position forward.

Mr Maynier replied that the DA will eventually reach their conclusions and propose their amendments but with regards the NCR, he was not aware of or presented with a compelling case by the NCR on why it should not be included in the architecture of the Financial Sector Regulation Bill. The NCR has not met with Committee and when he spoke to the Department of Trade and Industry, he was told that a political decision had been taken.

The Chairperson confirmed with the Committee that the NCR had previously briefed the Committee.

Ms Tobias confirmed this and remarked that Mr Maynier is hardly present at meetings.

The Chairperson said Mr Maynier is a liar. The fact that Mr Maynier was not compelled by the NCR’s arguments does not mean that the NCR had not put forward any compelling arguments.

Ms Tobias added that in the history of this Parliament, a Chairperson with the calibre of Mr Carrim will not come around again. She said the manner in which “we” try to reach out in accommodating opposing views is not something that is common. She condemned the manner in which Mr Maynier had approached the Chairperson by casting aspersions on more than one occasion.

Mr Maynier replied that what Ms Tobias had said is a lie. He had not cast any aspersions and if aspersions had been cast it was by the Chairperson himself. He had been called a liar twice in the meeting and that he is sick of such treatment. Mr Maynier packed up and departed the meeting in anger.

The Chairperson expressed that he does not care and further accused Mr Maynier of lying. He asked that the meeting commence.

Mr Dixon said that on contested issues, the biggest one is around exemptions. The JSE had expressed that they are not in favour of exemption in the Financial Markets Act. However, the JSE itself has asked for a five year exemption from the law.

Mr Dixon said that another issue that came up during the previous draft of the Bill was around the new requirements of the Financial Advisory and Intermediary Services Act. The definition under the Act was therefore being extended to include intermediaries. There has been a lot of engagement with ASISA on this issue. This is from the new comments matrix on schedule 4 which was would be discussed in the subcommittee meeting the next day.

The meeting was adjourned.