Report of the Portfolio Committee on Finance on a Study Tour to Australia and New Zealand during the period 5 - 15 June 2005: "Rationalisation of the Regulation of the Financial Services Sector", dated 21 October 2005:

Between 5 and 15 June 2005, members of the Portfolio Committee on Finance undertook a study tour to Australia and New Zealand to learn from those countries’ experiences of rationalizing institutions responsible for the regulation of the financial sector. The present study tour needs to be seen as complementing a similar study tour to Britain undertaken by the Portfolio Committee on Finance in the previous parliament. The present report needs to be read together with the report on that visit published in the ATC dated 4 December 2003.

An active debate is underway in South Africa about rationalizing the institutions responsible for regulation of the financial sector. At present prudential regulation of the banking sector is the responsibility of the South African Reserve Bank, while a number of other institutions reporting to three government departments are responsible for prudential regulation of other financial institutions and market conduct/consumer protection. In addition, issues of transformation and extending financial services to lower income people are being dealt with through the Financial Sector Charter Council. While no firm decisions have yet been taken on the precise form which a rationalization process in South Africa should assume, there is a growing consensus that simply maintaining the status quo is not an option.

The British "model", studied by our predecessors in the last Parliament, represents one key experience. In 1997, the Labour Government established a single financial regulator, the Financial Services Authority. As with most significant reform episodes, this was given impetus by a perceived failure of the previous regulatory system – in this case prompted by the collapse of the Barings Bank. The essential feature of the British single financial regulator model is that one authority, the Financial Services Authority, is responsible both for prudential regulation of all financial institutions and for market conduct/consumer protection regulation. Under this system, the Bank of England has no direct role in prudential regulation of the banks, but retains responsibility for overall stability of the financial system – a responsibility which it discharges mainly through the publication of a regular Financial Stability Report.

The Australian system represents a significant systemic alternative to the British single regulator model – known as the "twin peaks" model. It came into existence in 1998, as a response to recommendations of the Financial System Inquiry (the Wallis Committee) report published in 1996. One of the significant factors underlying the Australian reform was a perception that lines of demarcation between the operation of banks and other financial institutions were becoming blurred and that a system of prudential regulation that focused largely on banks was inadequate to the emerging reality of financial markets. The essential feature of the Australian "twin peaks" model is the establishment of two distinct institutions responsible for prudential regulation and market conduct/consumer protection regulation respectively.

The Australian Prudential Regulatory Authority (APRA) is responsible for the supervision of banks, long term and short term insurance companies and superannuation (retirement) funds. As in the British system, the Reserve Bank has no direct responsibility for prudential regulation of the banks – although it retains responsibility for monetary policy and the maintenance of financial stability, including stability of the payments system.

The other "peak" in the Australian system is the Australian Securities and Investments Commission (ASIC) which is responsible for market conduct and consumer protection across the financial system. ASIC is also responsible for company registration (not just of financial sector companies) as well as insolvency and securities regulation. It has a large enforcement division staffed by lawyers, analysts and investigators that prepare cases for prosecution.

Both APRA and ASIC operate independently of government but according to mandates set out in laws and policy directives set out by Treasury Ministers. They both participate, along with the Treasury and Reserve Bank, in the Council of Financial Regulators (CFR) that operates as a coordinating mechanism.

New Zealand does not represent a systemic model, but is interesting as a country that is moving from a system described as "light regulation" towards establishing a stronger system of regulation. New Zealand has specific characteristics arising from the fact that most financial institutions operating in the country are Australian. The system to adopt is, nevertheless, subject to debate with no obvious indication that the Australian model will necessarily be adopted in New Zealand.

The Committee was extremely fortunate to be able to meet with a broad range of knowledgeable persons from most of the significant institutions as well as with academics who have followed developments in the field. This included the Chairpersons of both APRA and ASIC (for a full list of respondents see Appendix).

All respondents from Australia expressed general satisfaction with the "twin peaks" system and indicated that there was no dynamic that would lead Australia to adopt a single financial regulatory system in the near future. A number said that they were not necessarily recommending it as a model for others to emulate, or arguing that it was better than the single financial regulatory system, but all felt that it was working well in Australia. Even respondents from the Reserve Bank, who acknowledged that the Bank had initially opposed taking bank supervision away from it, said that they believed that the model was working well and said that they had close working relationships with APRA.

APRA had, however, undergone a major challenge within two years of its establishment with the case of the HIH insurance company. HIH was a general insurance company which collapsed amidst indications of serious fraud in connection with re-insurance deals. Several of its top executives were later convicted of criminal offences. APRA informants told us that the perception underlying the creation of APRA – that the distinction between banks and insurance companies had become blurred – had initially led APRA to under estimate the need for its staff members to develop specialist focuses on particular institutions. We were told that this had since been corrected and that staff members are now focusing on a main sector, in addition to maintaining a broader watch over others.

Respondents at ASIC were perhaps the strongest proponents of the "twin peaks" model. They pointed, first, to the arguments put forward in the Wallis Commission. It had argued that a single regulator model would create an authority that would be too powerful and too unwieldy. The Commission felt that it was too early to move in this direction and therefore recommended trying the "twin peaks" system first. Another point made by the Commission was that the "culture" of prudential and market conduct/consumer protection regulation differed significantly. The latter point was emphasized by a number of respondents in ASIC. They argued that there was an inherent "clash of cultures" between the two types of regulatory activity. In the Australian context, this came to a head on the issue of disclosure. The fundamental philosophy of ASIC was that consumer protection would be enhanced by maximum disclosure. Review of the fairness or otherwise of contracts was not the real focus of market conduct regulation by ASIC. Rather the emphasis was on ensuring that clients received full information about the contracts they were entering into and that markets were provided with full information about any change in the circumstances of market players.

The prudential regulator, APRA, on the other hand sometimes favoured non-disclosure to the market in cases where it judged disclosure might provoke a market reaction that would jeopardize systemic stability. Our respondents argued that such tensions were inherent in any regulatory system that embraced both functions. Respondents in ASIC tended to argue that the twin peaks model with the Council of Financial Regulators (CFR) operating as a clearing house for decisions in the event of a conflict of views was preferable to the British FSA model where the conflict would be sorted out "in house" in the agency. They indicated that the principle established in the CFR was that where there was a clear prudential regulatory imperative, this would trump the market conduct regulator’s positions, but that information would be made available to the market as soon as possible. However, there were many decisions where a "trade off" was required and both ASIC and Treasury respondents argued that one of the major advantages of the "twin peaks" plus CFR model was that where such a trade off had to be made it would be more transparent, the product of open dialogue and, with Treasury representation on the CFR, be seen as a decision with the political backing of government – which would be ultimately responsible. APRA respondents were, however, somewhat less sanguine arguing that taking "trade off" issues to the CFR sometimes meant "messy" external fights that under the British FSA model would be settled internally.

The New Zealand experience is relevant in that they are seeking to change and strengthen their regulatory system. For more than 20 years, the country has had what was repeatedly described to us as "light regulation". The system had relied on three pillars:

Self-regulation by institutions;

Market discipline; and

Regulatory discipline.

For most of the past two decades it was the first two that were most emphasized, with the third being "light handed". For non-bank institutions all that was required was disclosure to clients. Insurance companies, for example, do not have to be licenced but have to either secure an agency rating or advise clients that they have opted not to seek such a rating. The definition of banks (subject to regulation by the Reserve Bank) is based only on the use of the term "bank" in the name of the institution not on the function performed. Any finance company can accept deposits and carry out functions normally associated with a bank as long as it does not call itself a bank. For banks supervised by the Reserve Bank, the system in place is based on meeting the Basel 1 requirements with the Bank moving towards implementing Basel 2. However, the Reserve Bank does not itself monitor compliance with capital adequacy requirements etc. This, rather, is monitored through outside auditors that reported to the Reserve Bank. The Reserve Bank can, however, give directions via the Minister of Finance to place defaulting banks in statutory management. These, in practice, are very few and far between. A Treasury official told us that the difference between APRA and the New Zealand Reserve Bank (NZRB) is that APRA issues directives, whereas the NZRB "has a chat" with any institution about which it is concerned.

We were told that there was a growing feeling in New Zealand that this system of "light handed" regulation was not adequate. Amongst other things, the country had seen the emergence of a number of unregulated finance companies that were both unsafe and were charging exorbitant interest. Although we were told that none of these posed any serious risk to the systemic stability of the New Zealand financial system, significant numbers of people were at risk of losing savings and deposits. There was thus a move afoot to reform the system and the Ministry of Economic Development was preparing a discussion document identifying options in this regard. We were also told that legislation on financial intermediaries was likely to be tabled shortly.

We did not receive any clear indications of what form a strengthened system of financial regulation in New Zealand would take. However, several principles and considerations were mentioned to us. First, we were told that decisions on institutional arrangements would be based on a clear identification of the outcomes that regulatory reform was expected to achieve. Second, there are the specific circumstances of New Zealand where most banks are Australian subsidiaries subject to APRA regulation and also to a rule which prioritises Australian over other clients in the event of liquidation. Third, there is a view in New Zealand that APRA is too "hands on" and that it may not make sense, in view of the smallness of the country, to try to replicate the two Australian institutions – suggesting perhaps a preference for the single regulatory model. Finally, there is no clear decision that bank supervision should be taken away from the Reserve Bank.

Decisions on reform and rationalization of the system of regulation of the financial sector in South Africa cannot involve simply looking at "models" as they operate in other jurisdictions and then having an abstract debate as to which is "the best". Rather such decisions need to be based on an analysis of our own specific circumstances and the outcomes we need to achieve in South Africa from a process of reform. It is only in that context that consideration of "international experience" becomes relevant.

The circumstances in both Australia and New Zealand are very different from those in South Africa, and the challenges and priorities of regulation in these jurisdictions are thus different in important respects from those facing us in South Africa. Both Australia and New Zealand are higher income OECD countries. Neither is grappling as serious priorities with issues of transformation or of extending affordable financial services to large numbers of excluded people. The system of consumer protection in both Australia and New Zealand is based largely on disclosure – on the principle that consumers are rational market players who will take appropriate decisions if provided with full information. In our circumstances, the need also to defend vulnerable consumers against unfair provisions in contracts has been evident e.g. in a number of recent rulings of the Pension Funds Adjudicator. Finally, any decisions on reform/rationalization must be based on a careful identification of available human resources (as well as the human resource implications of any change) and not on the simplistic "importation" of models from elsewhere where such considerations may not apply in the same way.

Having said that, the issue of a "clash of cultures" between prudential and market conduct/consumer protection regulation does seem to us to be important. Historically, in South Africa we have had fairly "sophisticated" long established prudential regulation but consumer protection and transformation/extension of financial services is more recent and yet to fully find its feet. Whatever regulatory reform model is eventually adopted must, therefore, in our view, provide for transparent, open and politically informed decision-making on any "trade offs" that may occur between the two forms of regulation. Above all it must not allow what are "new issues" in our context of consumer protection and transformation to be swamped by more established and possibly more traditional views on prudential regulation. Secondly, the decision to take bank supervision out of the Australian Reserve Bank into APRA was made viable by the ability to transfer most of the existing bank supervision staff to the new agency and to establish within a short space of time that APRA would provide the same or better levels of remuneration, prestige and job satisfaction than the Reserve Bank. Whether the same conditions apply in South Africa is something that would have to be carefully assessed in any consideration of establishing either a single regulator or a body like APRA.

The Committee wishes to express its profound thanks to all those in Australia and New Zealand who shared information with us and also to the New Zealand Parliament for providing us with a Committee room in which to conduct our meetings.

Dr R Davies, Leader of delegation

Mr K A Moloto

Mr M L Johnson

Mr B A Mnguni

Mr L Gabela

Ms B Hogan

Mr I Davidson

Dr S M van Dyk

Mr M Stephens

Mr T E Vezi

11. Mr A Hermans, Committee Secretary

B. List of Persons Consulted

The Hon B Baird, Australian MP, Chairperson: Standing Committee

on Economics, Finance and Public Administration

The Hon C Bowen, Australian MP, Deputy Chairperson: Standing

Committee on Economics, Finance and Public Administration

The Hon L Tanner, Australian MP

Dr J Laker, Chairperson: APRA

Dr R Jones, Deputy Chairperson: APRA

Mr C Gaskell, Head International Relations: APRA

Mr S Somogyi, APRA

Mr J Lucy, Chairperson: SIC

Mr G Tanzer, Executive Director: Consumer Protection: ASIC

Mr M Rodgers, Executive Director: Regulation: ASIC

Ms S Chan, Lawyer, International Relations: ASIC

Dr P Lowe, Assistant Governor: Reserve Bank of Australia

Dr T Richards, Head: Economic Analysis: Reserve Bank of Australia

Dr M Orsmond, Deputy Head: Economic Analysis: Reserve Bank of

Australia

Mr J Murphy, Executive Director: Markets Group, Australian

Treasury Department

Mr D Love, Manager of Investor Protection Unit: Australian

Treasury Department

Ms L Allan, Acting Manager pf Prudential Policy: Australian

Treasury Department

Prof M Sathye, Head of Accounting, Banking and Finance Discipline

and Deputy Head: School Of Business and Government: University of Canberra

H.E Mr A Mongalo, South African High Commission

Mr L Mason, General Consul: Securities Commission, New Zealand

Hon C Cosgrove, New Zealand, MP, Chairperson: Finance and

Expenditure Committee

Hon G Copeland, New Zealand, MP, Deputy Chairperson: Finance

and Expenditure Committee

Hon C Carter, MP, Minister of Ethnic Affairs, New Zealand

Ms F Barker, Senior Analyst: Macro Policy, Australian Treasury

Department

Ms L Thomson, Manager: Legal Services: Ministry of Economic

Development, New Zealand

Mr B Layton, Director: New Zealand Institute of Economic Research

and Development

Mr B Scroope, Analyst, Ministry of Economic Development, New

Zealand

Ms H Lan Yap, Senior Analyst, Ministry of Economic Development,

New Zealand

Mr G Mortlock, Reserve Bank of New Zealand

Mr I Woolford, Reserve Bank of New Zealand