FINANCIAL SERVICES BOARD PRESENTATION TO THE PORTFOLIO COMMITTEE ON FINANCE AND THE NATIONAL COUNCIL OF PROVINCES ON THE FINANCIAL ADVISORY AND INTERMEDIARY SERVICES BILL, 2001 (the Bill / the FAIS Bill)

  1. BACKGROUND
  1. Consumer protection lies at the root of this proposed legislation.
  2. Unlike the situation in comparable jurisdictions, in South Africa there is almost no law regulating financial intermediaries.
  3. There has been a long felt need for such regulation as evidenced, inter alia, by the findings of the Commission of Inquiry into the Affairs of the Masterbond Group and Investor Protection in South Africa (November 1997).

(d) The task of conceptualising and designing appropriate legislation to cover this regulatory deficiency was accepted by the Policy Board for Financial Services and Regulation (the Policy Board) in 1998. After several meetings and workshops the Policy Board in December 1998 produced a basic framework for this law.

2. POLICY BOARD FRAMEWORK

  1. The rationale, objectives and elements of this legislation as originally perceived by the policy Board are set out in attachment A. This reflects the thinking of the Policy Board as at December 1998.
  2. The initial intention was to regulate the activities of "financial advisers" and the focus of the regulation would only be on advice in respect of investment products, including insurance products with an investment component.
  3. Investor protection was re-confirmed as the main objective of the intended regulation of financial advisers.
  4. Advice in respect of debt instruments, mainly bank deposits, had to stay outside the envisaged regulatory net.
  5. Regulation was to be achieved through entry requirements and the setting of standards for the market conduct of advisers so as to achieve professionalism of advisers.
  6. The Financial Services Board (FSB) was mandated to draft the necessary legislation and to conduct the consultation process which was required.

3. CHANGES TO THE ORIGINAL CONCEPT

  1. As could be expected with comprehensive legislation in an area hitherto not regulated, it soon became apparent that the original concept for this law needed to be re-visited. In fact the pattern of reviewing was repeated as the drafting of the law proceeded and as it became exposed to public scrutiny and comment.
  2. Very early the rationale for limiting the ambit of the law to Ainvestment products, including insurance products with an investment component@ and the exclusion of advice in respect of bank deposits, came to be questioned. The result of the debates which ensued was that the range of financial products which were to be defined in the Bill was expanded drastically to cover most financial products and instruments, including bank deposits.
  3. A major revision of the ambit of the Bill came about after the second draft of the Bill had been work-shopped and commented upon by a large number of interested parties. The FSB came to realise that if the ambit of the Bill was to be confined to financial advice giving, a large number of intermediaries actually engaged in the insurance and investment sectors of the financial services industry, would escape the regulatory net.
  4. To overcome this gap the terms of the Bill were expanded to include "intermediary services" in addition to the furnishing of "advice". This extension resulted in the activities of investment managers, hitherto regulated under financial markets legislation, being brought under the jurisdiction of this new law. With the wide definition of "intermediary services@, there can no longer be any doubt that the activities of the entire broker fraternity in both the long-term and the short-term insurance industries, as well as those of portfolio or fund managers, are squarely covered by the provisions of the Bill.
  5. The changes to the FAIS Bill from the original framework set by the Policy Board were fully motivated to the Policy Board in a memorandum by the FSB (attachment B) which was accepted by the re-constituted Policy Board on 18 February 2000.
  6. Following intense further debates on the inclusion of bank deposits in the definition of financial products, a further significant amendment to the Bill had been introduced by the time it was finally adopted and ratified by the Policy Board. This amendment was to accommodate representations by the Banking Council on behalf of banks. The amendment had the effect of excluding from the definition of advice, the advice by a bank on its own deposits. Simultaneously an ancillary amendment was introduced to the definition of "intermediary services@ to make clear that when a bank merely facilitated through its debit order system the payment of (for example) insurance premiums, that would not be regarded as intermediary services within the meaning of the Bill.
  7. The last material amendment to the Bill was effected subsequent to its lodgment with National Treasury on 7 August 2000, and related to the position of health brokers who are accredited under the Medical Schemes Act 1998. The effect of this amendment was to exclude health brokers from the provisions of the Bill to the extent that the rendering of financial services by such brokers is regulated by the Medical Schemes Act.
  8. The last two amendments referred to under paragraphs (f) and (g) have since their introduction in the Bill become controversial and are likely to form the subject of debate during the passage of the Bill through the Parliamentary process. (This controversy will be dealt with later in this submission. The FSB will propose amendments dealing with these two matters.)

4. THE GENERAL SCOPE OF THE BILL: WHAT DOES IT COVER AND WHAT NOT?

  1. The first point to understand is that the Bill has a functional and not an institutional approach. It regulates a function, not a person or an institution directly.
  2. Therefore, if a person performs a function which the Bill intends to regulate, that person will have to be licensed under the Bill, irrespective of whether the person is a product supplier (already licensed under some other law) or an intermediary (broker) or an investment manager.
  3. The functions which the Bill seeks to regulate are:

"Financial service@ means any one of these services (clause 1(1)(xvii)) and a "financial services provider@ means a person who as part of a regular business renders any one of these services (clause 1(1)(xix)).

(d) In each instance the "advice@ or "intermediary service@ must relate to a "financial product@ (clause 1(1)(xvi) which embraces almost every investment or insurance product or instrument available in the market place.

(e) However, the "financial service@ (being advice or an intermediary service) must be rendered to a client who can be a natural person or a corporate entity. (An amendment clarifying the meaning of "client" will also be proposed.) The furnishing of "advice@ relating to a "financial product@ by a financial adviser to a corporate client will, therefore, be covered by the Bill.

(f) Again, if the advice will relate to anything else than a "financial product@ (e g a homeloan); or if the advice is not furnished as part of the person=s regular business but incidental to another business or profession; or not directed at a client (e g an article in a financial journal addressed to the public at large), all of this will fall outside the ambit of the Bill.

(g) In practice one will find that product suppliers who engage in direct advice to clients, or direct selling, the activities of insurance intermediaries, those of financial planners, and the management of investments or advice on investments, will all fall under the Bill. The wide definition of "advice@ (clause 1(1)(i)) and "intermediary service@ (clause 1(1)(xx)) will take care of this.

(h) Examples were given in (f) above of activities which fall outside the scope of the Bill. These were inferred from the relevant definitions contained in clause 1(1) of the Bill. However, in clauses 1(2), (3) and (4) the Bill is explicit as to what is excluded from the terms "financial product@, "advice@ and "intermediary service@. Notable under these exclusions are:

5. FINANCIAL SERVICES PROVIDERS (FSP) AND THEIR REPRESENTATIVES (REP)

  1. As explained above, a FSP is a person who conducts the business of furnishing "advice@ or rendering "intermediary services@ or does both (clause 1(1)(xix)).
  2. A "representative" (rep) engages in the same activities but does so for or on behalf of the FSP (clause 1(1)(xxxii)) - either because he is an employee of the FSP or because he holds a mandate from the FSP.
  3. FSP=s must be licensed in terms of the Bill (clause 8) and will have to comply with certain prescribed criteria relating to:
  1. The licence may be granted subject to certain conditions and restrictions (clause 8(4)), need not be renewed, but may be suspended (clause 9) or withdrawn (clause 10).
  2. A rep need not be licensed but cannot render "financial services@ otherwise than on behalf of a licensed FSP and must be able to show to the clients of the FSP that:

(f) The FSP furthermore bears the following responsibilities with regard to his reps -

6. METHODS OF REGULATION

(a) The Bill seeks to establish a professional group of financial services providers (FSPs) in South Africa.

(b) The methods towards the achievement of this goal are:

  1. GENERAL SCHEME AND FEATURES OF THE BILL

(a) Like other Acts administered by the FSB, the Bill creates a registrar who is the executive officer of the FSB (clause 2 etc).

  1. There will also be an Advisory Committee (representative of industry and consumers) with whom the Registrar must consult on all important issues (clause 5).
  2. The registrar may delegate his powers, inter alia, to "any body recognised by the Board@ (FSB) (clause 6(3)(a)(iii). This creates the opportunity for the FSB to administer the law in conjunction with recognised industry bodies which could (e g) assist with the licensing process, enforcement of codes, compliance related matters, etc.
  3. An outstanding feature of the Bill is its flexibility of application. This will enable the regulator to rectify unintended consequences, to address cases of hardship, to ensure pragmatism in the application of the Act. A few examples may illustrate this point -
  1. EXEMPTIONS
  1. The Bill itself provides for the exemption of certain persons from its provisions. These may be divided into two categories (clause 45(1)(a) and (b)).
  2. The first category are persons or entities who are members of self-regulatory bodies (the financial exchanges) or where activities are regulated elsewhere (unit trusts management companies, pension fund administrators, medical scheme operators and health brokers).
  3. The exemption is stated to be "to the extent that the rendering of financial services is regulated by or under@ the Acts referred to in clause 45(1)(a).
  4. The second category of persons exempted are executors of deceased estates, curators, liquidators, trustees of non-business trusts and guardians of minors.
  5. In the latter case the exemption is also qualified - if these persons render the "financial service@ as a regular feature of their business, the exemption will not apply (clause 45(1)(b)).
  6. The motivation for these exemptions is, in the first instance, that the activities are sufficiently regulated elsewhere and/or that the services are rendered on a "wholesale@ basis; and, in the second instance, that the Bill does not wish to interfere in activities outside the financial services industry.
  1. REPEAL OF LAWS
  1. The repeals are two-fold: to make provision for the transfer of the supervision of investment (fund/portfolio) managers from the Stock Exchanges Control Act, 1985, and the Financial Markets Control Act, 1989, to this Act; to repeal the Policyholder Protection Rules (Long-term and Short-term) "insofar as it relates to the rendering of financial services as contemplated in this Act.@ (An amendment will be proposed dealing with the latter repeal.)
  2. It is important to understand the interaction between this new Act and the Policyholder Protection Rules (PPR). The two sets of PPR (which came into operation on 1 July 2001) were promulgated under the two Insurance Acts respectively and aim "to ensure that policies are entered into, executed and enforced in accordance with sound insurance principles and practice in the interests of the parties and in the public interest generally A(section 62 of the Long-term Insurance Act, No 52 of 1998).
  3. The PPR essentially deal with disclosure requirements. The FAIS Bill deals with disclosure requirements as well as other market conduct requirements – skill, care, diligence, analysis of needs, appropriate advice, conflicts of interest, etc. FAIS, therefore, goes much further in client care and consumer protection.
  4. The ultimate objective is to have FAIS apply to the "market conduct" of all "financial services providers" (that is both intermediaries and insurers who register under FAIS). To that extent the PPR will no longer apply to those intermediaries and insurers. Only those provisions of the PPR that have nothing to do with FAIS specific issues will remain in the PPR and applied to insurers (cooling-off, claims procedures, cessions, and the like).
  5. On the other hand, if an insurer’s business is structured in such a fashion that it need not register as an fsp under FAIS, that insurer should remain subject to all the provisions which the PPR impose on an insurer.
  1. SUBORDINATE LEGISLATION

(a) In most instances the FAIS Bill gives a relatively clear indication of the principles with which the subordinate legislation must comply. A good example is clause 16 which lays down in reasonable detail what principles should be adhered to in the codes of conduct.

(b) There is another reason why the subordinate legislation is unlikely to spring surprises on either industry or consumer. The Bill itself has had a history of public consultation over a period of more than two years. During this process much of what will be contained in the subordinate legislation was discussed, canvassed and thrashed out in public and private discussions, workshops, comment and other communications.

(c) In November 2000 the Policy Board issued an instruction to the FSB that the subordinate legislation under the Bill was to be framed in consultation with a broad working group. Open invitations were to be extended to industry bodies, consumer organisations and independents (academics, etc) to participate. This was done and the first meeting of these parties held in January 2001 was attended by 22 persons. Drafts of the subordinate legislation are presently forwarded to 73 persons.

(d) The process was started by an invitation to everybody to submit their proposals on the subordinate legislation which was required on the various aspects of the Bill. Submissions were received and the actual drafting was undertaken by a small FSB drafting committee, commencing work at the end of March 2001. In June 2001 certain other aspects were referred to a second specialist drafting committee with diverse representation.

(e) By the middle of August 2001 draft subordinate legislation had been produced on the following aspects of the Bill:

(i) Drafts circulated to members of the Drafting Working Committee:

(ii) Drafts on which expert advice has been sought (circulated only to specialist committee and internally in the FSB):

The drafts will have been forwarded to the larger working group consisting of 73 persons during September 2001 and will in due course be settled into final drafts. Thereafter they will be exposed publicly.

(f) Bureaucratic rule through subordinate legislation has been stifled by the Registrar having to consult with the Advisory Committee on all critical matters. Examples are contained in clauses 8(1) and 15(1) of the Bill. Entry requirements will be determined and codes of conduct issued by the Registrar after consultation with the Advisory Committee.

11. CONTROVERSIES

(a) While the first draft of the Bill which appeared in the earlier part of 1999 was almost greeted with hostility, attitudes in the ranks of industry changed significantly after later drafts had been exposed.

(b) This can mainly be ascribed to major amendments which were effected to the Bill after the Second Draft, resulting from the consultation process.

(c) The FSB believes that at this point by far the majority of industry players (or at least those that are members of industry organisations) as well as consumer representative bodies accept the main principles expounded in the Bill.

(d) However, controversial aspects which remain and which have been consistently criticized since their introduction into the Bill, by various interested parties, are the following:

  1. POSSIBLE AMENDMENTS TO THE BILL

(a) Banks

(i) The debate as to whether bank deposits should be included as a financial product for regulation by this law, started with the initial framework set by the Policy Board.

(ii) Very early in the drafting process it was appreciated that bank deposits should be listed as a financial product. Deposits form an integral part of many investment portfolios and do not only occur in the course of banking business.

(iii) Then came the argument on behalf of banks that the inclusion of bank deposits would "require the listing of each teller in the country@ as a "representative@ in terms of the Bill.

(iv) In order to accommodate the banking industry, advice by a bank on its own deposits was excluded from the definition of "advice@. If a bank advised on any other "financial product@, as most banks do, the persons involved in such advice , are covered by the Bill.

(v) The FSB=s motivation for the limited exclusion of banks was that the Bill was never intended to regulate banking services, which are regulated by another regulatory regime set up under the Banks Act. If a bank advised on its own deposits, that was seen to be incidental to banking services. If it went further and advised on other financial products, it would be hit by the FAIS Bill. This distinction, although accepted by the Banking Council, was consistently opposed by the Life Offices Association (LOA).

(vi) The FSB has reconsidered the matter and has decided that the appropriate way to go, is to limit the exclusion of banks to advice on short-term bank deposits, which are deposits with a term of one year or less. Advice on short-term deposits is in the nature of banking business/services, however when the term of a deposit exceeds one year, it becomes of the nature of investment, which is the domain of FAIS.

(vii) An amendment to give effect to this decision will be proposed to the Portfolio Committee when the Bill will serve before the Committee.

(b) Health Brokers

(i) Health brokers are accredited by the Council for Medical Schemes in terms of section 65 of the Medical Schemes Act, 1998.

(ii) All earlier drafts of the FAIS Bill made provision for the repeal of section 65(3) and (4) of the Medical Schemes Act, which would have resulted in health brokers being accredited under the FAIS Bill only. This was opposed by the present Registrar of Medical Schemes, the repeal of section 65(3) and (4) was withdrawn and, in addition, clause 45(1)(a)(vi) of the Bill was amended to make clear that "financial services@ by health brokers are exempted from FAIS "to the extent regulated by or under@ the Medical Schemes Act.

(iii) This amendment, which had the effect of totally excluding health brokers from FAIS, has been severely criticized by various parties, amongst others the LOA, the SAIA and the Association of Health Benefit Advisors (AHBA). The FSB concedes that the exclusion of health brokers from the provisions of FAIS, as it appears in the latest draft, was a mistake.

(iv) There are few health brokers that confine their business to health service benefits under the Medical Schemes Act. Most of these brokers are multi-business brokers and also operate in the insurance industry, and sometimes also in the investment advice business.

(v) "A health service benefit@ is also one of the financial products listed by FAIS (clause 1(1)(xvi)(g)).

(vi) It is only logical, therefore, that "financial services@ by health brokers should be covered by the provisions of the Bill. Whether they should be removed from the regulatory regime of the Medical Schemes Act, in the way investment managers have been removed from the financial markets legislation, is another question. If section 65(3) and (4) will not be repealed, it will result in health brokers having to be accredited in terms of the Medical Schemes Act, and licensed under FAIS as well.

(vii) An amendment will be proposed to the Portfolio Committee whereby the reference in clause 45(1)(a)(vi) of the Bill to section 65 of the Medical Schemes Act, will be withdrawn. Health brokers will thus be covered by FAIS, while still being accredited by the Medical Schemes Council. In time to come the situation of health brokers could be addressed either through exclusions under FAIS or rationalisation of the application of the Medical Schemes Act to health broker services.

(c) FAIS Codes of Conduct and the Policyholder Protection Rules (PPR)

(i) The contentious issues of how FAIS should interact with the PPR and what codes of conduct must be made applicable to what sectors of the industry have not been settled.

(ii) Two concerns have been raised, mainly by the LOA: firstly, there was uncertainty as to what will be transferred from the PPR to FAIS. The PPR was a product of the Insurance Acts with a different emphasis and focus than has FAIS, which is market conduct regulation. Some elements were common to both laws, others not.

(iii) The second concern was directed at the initial plan to have two dedicated codes of conduct, one each for the long-term and short-term insurance sectors, a further specific code for investment managers and one general code applicable to all sectors. The query was why should the insurance industries be subjected to specific codes, while there was none for the unit trust industry and banks (which, to add to the injury, were partially exempted from FAIS).

(iv) Having reconsidered the matter, the FSB proposes the following solutions:

− The proposed amendment will provide for a new provision (cl 44(5)) which will enable the Registrar to exempt an fsp from any of the provisions of the PPR. This will enable the objects dealt with in 9(d) and (e) above, to be attained.

13. COST EFFECTIVENESS

(a) This issue was dabated already at the inception of the discussions on the rationale of this legislation. Please refer to paragraph 5 of attachment A.

(b) When the first two drafts of the Bill had been exposed, a number of commentators expressed concern at the costs of compliance. These concerns subsided after the third draft had been publicised in which many of the concerns had been addressed.

(c) An important factor is that this Bill has been preceded by the promulgation on 1 July 2001 of the Policyholder Protection Rules under both the Insurance Acts. Insurers and their intermediaries had to adjust or gear up their systems in order to comply with those Rules. Similarly, investment managers have for long been subject to "conditions@ imposed under the financial markets laws. These are being reviewed and will be transferred to FAIS. If anything, FAIS will bring about no more than incremental costs to both the insurance and portfolio management industries.

(d) The FSB confidently expresses the opinion that the long-term consumer benefits introduced by the FAIS legislation will overshadow the cost of regulation and compliance of this law, even though these costs may be passed on to the consumer.

(e) As a matter of prudence the FSB nonetheless has caused a professional cost-benefit analysis to be prepared of this Bill, the results of which are available should the Portfolio Committee wish to be addressed on the issue. Suffice it to say that the findings of the consultants were favourable.

LEGAL DEPARTMENT

FINANCIAL SERVICES BOARD

17 September 2001