ATC160527: Report of the Standing Committee on Finance on its Study Tour to the United Kingdom from 07 to 11 December 2015, dated 17 May 2016

Finance Standing Committee

REPORT OF THE STANDING COMMITTEE ON FINANCE ON ITS STUDY TOUR TO THE UNITED KINGDOM FROM 07 TO 11 DECEMBER 2015, DATED 17 MAY 2016

 

1. Introduction

The Standing Committee on Finance (SCOF) was established in terms of the Money Bills Amendment Procedure and Related Matters Act, No 09 of 2009 (Money Bills Act). In terms of section 4(1) of the Money Bills Act, each House must establish a Committee on Finance whose powers and functions include considering and reporting on the following matter:

• the national macro-economic and fiscal policy;
• amendments to the fiscal framework, revised fiscal framework and revenue proposals and Bills;
• actual revenue published by the National Treasury; and
• any other related matter set out in this Act.

 

The National Treasury (NT) introduced the Financial Sector Regulation Bill [B34 – 2015], more commonly referred to as the “Twin Peaks” Bill, to Parliament on 27 October 2015. The “Twin Peaks” Bill seeks to completely overhaul the financial sector in South Africa. Some experts suggest that it will be the most significant change to the South African financial sector since the 1920s. It is linked to other Bills, including the Insurance Bill, the Conduct of Financial Institutions Bill, the Resolution (Insolvency and Business Rescue) for Financial Institutions Bill, and a new Financial Markets Bill that will be introduced over the next few years.

 

In presenting the “Twin Peaks” Bill, the NT explained that, as they see it, the last 25 years have been a period of enormous transformation in the financial services sector. The sector has seen a marked shift from domestic firms engaged in distinct banking, securities, and insurance businesses to more integrated financial services conglomerates offering a broad range of financial products and operating both domestically and internationally. These fundamental changes in the nature of how financial institutions operate exposed the shortcomings of the current South African financial legislation.

 

South Africa is not immune to global shifts. South African financial institutions have moved from a narrow, largely domestic-focused financial sector to one that has clients all over Africa. Financial institutions also source funding from major financial sectors in Europe and the United States of America (USA). Given these shifts, South Africa’s financial sector is unrecognisable from the current legislative framework it was designed to regulate. Internationally, financial regulation is also undergoing significant reforms as a consequence of the 2008 global financial crisis.  

 

Despite this, South Africa has not changed its framework for financial regulation since the creation of the Financial Services Board and the Office of the Registrar of Banks in 1990. The major shifts referred to above require finance ministries, central banks, and supervisors to review their supervisory structures, especially to consider the extent to which they are effective in dealing with, amongst others, the collapse of systemically important financial institutions.

 

Several countries have changed their policies and legislation because of specific crises, like the emerging markets crisis of the late 1990s and the global crisis from 2008 onwards. In South Africa, the government has proposed a new approach to financial regulation, seeking to ‘fix the roof while the sun is shining’. Undertaking reforms in this context can be difficult because of the resistance from industry for ’unnecessary’ regulations. The NT has proposed the “Twin Peaks” Bill based on the current structure of the South African financial sector, and drawing on the experience of other countries, including Australia, the Netherlands, Belgium and the United Kingdom (UK). Chile has also indicated that it is to move to a “Twin Peaks” model type structure. This approach will create two separate financial sector regulators: a market conduct authority and a prudential authority. The market conduct authority will focus on how financial service firms sell, market and distribute products. It will also be responsible for financial market integrity. The prudential regulator will focus on the financial strength of individual financial services firms.

 

1. UK Study Tour Terms of reference

Against the background of what is covered above, the SCOF undertook the “Twin Peaks” Bill Study Tour, in brief, for the following reasons:

 

1. The “Twin Peaks” Bill aims to completely overhaul the financial system in South Africa, and it is said to constitute the most significant changes made to the financial system since the 1920s.
2. The Bill is significantly shaped by the consequences of the global financial and economic crisis of 2008 onwards and several countries, including the UK, have changed their financial systems to take account of these consequences. The UK thus provided useful lessons for the SCOF to take into account.
3. The NT visited several relevant countries in developing the Bill, and in their briefings to SCOF on drafts of the “Twin Peaks” Bill, they often refer to the experiences of Australia, the Netherlands and United Kingdom (UK) to explain some of the policy positions taken in the Bill. NT suggested to SCOF that the Committee considers visiting some of these countries to better understand the issues and more effectively process the “Twin Peaks” Bill. The Committee decided on undertaking a study tour to the UK, as its “Twins Peak” model has the most useful lessons to offer South Africa, and London is so crucial to the global financial system. 
4. All SCOF members are new to the Committee, and in view of the “Twin Peaks” Bill being technically complex, far-reaching and highly contested, it was envisaged that the study tour would provide the members with the necessary knowledge and best practices to engage with the technical and complex nature of the Bill.
5. Among the key issues that SCOF explored are:
   1. How can Parliaments more effectively ensure that regulators are held accountable? In some jurisdictions Parliament has a strong role in holding regulators to account for their actions. This is particularly important when, for example, a bank fails.
   2. What is the role of Parliament, the Executive and the regulators in setting laws, regulations and rules for the financial sector? Financial sector regulations are increasingly complex – some countries require all rules that apply to the financial sector to be passed by Parliament (primary legislation); other countries allow this to be exercised by the Executive (through regulations); while yet other countries allow regulators to issue their own requirements within the constraints of the law.
   3. How can the risks of cross-border transactions be reduced? Financial services firms increasingly operate across borders. A large-scale financial failure in one country (e.g. Barclays Bank in London) can have enormous knock-on effects for a bank in South Africa (e.g. ABSA), because of their shareholding.
   4. What is the appropriate balance between different policy objectives? For example, in the UK there is a scheme to help home ownership (“Help to Buy”). Some have argued that this has led to a house price bubble, creating massive potential risks.
   5. How does one protect the fiscus from bank failures? Bank failures can impose enormous costs on the taxpayer, crowding out spending on other items. The UK lost a number of banks in recent years, and their experience in reducing taxpayer losses will be invaluable.

 

The SCOF also took the opportunity to engage with key stakeholders, on matters of common interest, such as the ongoing global volatility.

 

The Committee has had a lot to attend to since returning from the study tour, including the Revenue Laws Amendment Bill (B4 – 2016) and the Financial Intelligence Centre Amendment Bill (B33-2015), the processing of the Budget and the Budget Vote of National Treasury, as well as other pressing oversight work. The 2016 Parliamentary term has also been significantly reduced to make way for the local government elections.  The Committee has had to postpone processing the “Twin Peaks” Bill until after the August elections, when it will give concerted attention to it. Hence the delay in processing this report. The Committee would otherwise have processed the report within the first four weeks of the first parliamentary term this year.

 

1. Parliament of South Africa and National Treasury delegation

 

The delegation from Parliament was as follows:

1. Mr YI Carrim (Chairperson, African National Congress)
2. Ms TV Tobias (African National Congress)
3. Ms PS Kekana (African National Congress)
4. Mr D  Maynier  (Democratic Alliance)
5. Mr  F Shivambu (Economic Freedom Fighters)
6. Mr  AG Wicomb (Committee Secretary)
7. Ms  B Diutlwileng (Senior Researcher)
8. Dr  DJ Jantjies (Parliamentary Budget Office)

The delegation from the National Treasury was as follows:

1. Mr Roy Havemann (Chief Director)
2. Ms  Kershia Singh (Deputy Director)

 

1. Overview of the Institutions, Organisations and Individuals that the delegation engaged with

 

The SCOF delegation met with various institutions and some individuals to discuss the UK Financial Sector reform processes and their general experiences since the implementation of the regulatory reform in 2012. The SCOF Chairperson also requested the hosting institutions to offer any comments they might have on South Africa’s “Twin Peaks” Bill.

4.1 Her Majesty's Treasury

The UK Her Majesty's (HM) Treasury is the equivalent of South Africa’s NT and has a similar responsibility of overseeing the UKs public finances. The UK HM Treasury played an important role in the introduction of the Financial Sector regulation reforms following the failure of the previous system, known as the tripartite regulatory system. The latter system consisted of the Financial Services Authority (FSA)[1], Bank of England (BoE) and HM Treasury. According to HM Treasury, the reforms attempted to clarify institutional responsibilities with regards to prudence and conduct authority within the UK financial sector. In the previous system, there were uncertainties with regards to the regulatory roles between the Financial Services Authority (FSA) and BoE.

 

The initial UK financial sector regulatory reforms were proposed as early as June 2010, which was during the global financial crisis period. The financial institutions irresponsible conduct was a major root cause of the financial crisis.  The UK Parliament drove the reform, and in July 2011 the first Bill was passed. The Financial Services Act received royal assent in December 2012. Also in 2012 an independent commission on banking was established. The regulatory model came into effect on 1 April 2013.

 

The HM Treasury signed a statutory Memorandum of Understanding (MOU) with the BoE setting out the revised financial sector regulatory framework. The Prudential Regulation Authority (PRA) was established as a subsidiary within the BoE. The PRA plays a regulatory role primarily by promoting the safety and soundness of deposit-takers, insurance firms and investment firms. It introduced new objectives for institutions that pose the greatest risk of financial failure. The Financial Policy Committee (FPC), also established within the BoE, monitors and responds to systemic risks at a macro level and also sets macro prudential policy. The changes made by the PRA included reforms to deal with the instability of the period, introduction of ring-fencing of the investments of consumers and objectives related to insurance regulation. The amendments to the regulations provided for ring-fencing and the creation of a separate commission on Banking Standards.

The Financial Conduct Authority (FCA) established in terms of the new regulatory framework as a company limited by guarantees, supervises about 73 000 firms with the aim of ensuring that the relevant markets under its control operate effectively. The FCA seeks to protect and enhance the integrity of the UK financial system, promote effective competition in the interests of consumers, and secure an appropriate degree of protection for consumers.

 

According to HM Treasury, the UK “Twin Peaks” regulatory framework seeks to strengthen regulatory responsibility and prevent reckless banking practises. Irresponsible and reckless banking practises are now criminal acts. The HM Treasury accepted the Parliamentary Committee on Banking Standards (PCBS) recommendation to establish a new competition regulator, known as the Competition and Markets Authority (CMA). The creation of the CMA with a focused mandate on competition saw responsibility for consumer credit regulation being transferred to the FCA. According to the regulatory framework, the regulators are independent from government. Regulators are accountable to Parliament and the HM Treasury is involved in terms of setting the jurisdiction of the regulators. .

 

The HM Treasury seeks to ensure effective coordination and assists in minimising overlaps of functions between the different regulators. This is achieved through strategic coordination of the cross-membership of boards, MOUs between the regulators and HM Treasury, and allowing the PRA a veto on specific FCA decisions but only if it would have a detrimental impact on firms. The PRA must provide HM Treasury with a copy of the intended veto, which Treasury can submit to Parliament for consideration. Both FCA and PRA are audited by Parliament auditors and this could minimise working differences of these regulators. Other reforms to the UK financial sector regulatory framework was a need to ensure the inclusivity of the financial sector. This was done by introducing the Money Advice Service (MAS) as a standalone body funded through industry levies collected by the FCA, and Parliament advocated for the FCA to consider access to services.

 

1. British Banking Association

The British Banking Association (BBA) is the leading trade association for the UK banking sector with two hundred member banks, and has offices in over fifty countries with operations in 180 jurisdictions worldwide. Eighty per cent of global Systemically Important Financial Institution (SIFIs) are members of the BBA. As the representative of the world’s largest international banking cluster the BBA is the voice of the UK banking sector. The BBA supports regulators in dealing with issues of financial crime, and it also plays a mediatory role between the industry and government, which is important in fighting financial crime.

 

According to the BBA, the UK financial sector legislation has tried to strike a balance through considering factors such as whether legislation creates an inclusive environment, whether the policy environment is predictable and if it assists businesses to plan over the medium-term. Other considerations include: is there a balance in terms of changes to policy and procedure, does the financial sector regulation take into consideration the needs of the Small, Medium and Micro Enterprises (SMMEs) and other smaller institutions, and is it sensitive to these? According to the BBA, the new financial sector regulation in the UK has encouraged clear leadership, accountability and responsibility.

 

The role of the BBA leading up to implementation of the “Twin Peaks” model in the UK entailed setting up communication forums and taking part in dealing with certain impediments to its implementation. The BBA engages with Parliament about every two months. Its accountability role is therefore very robust and it played an important role in ensuring that all stakeholders responded to the (Parliamentary Commission on Banking Standards)PCBS  report.

 

The Banking Standards Board develops rules that must be applied strictly by institutions. According to the BBA, there is a clear emphasis on culture and ethics but there must also be a balance between regulation and economic growth. The industry has been served with several fines, most of which are for the breaching of rules. BBA members are expected to act with due diligence and disclose information to the regulators if requested to do so.

 

It was pointed out that European Union (EU) and UK financial sector policies could have unintended consequences for Africa and Asia. It is therefore important to understand European policies and their impact on Africa and Asia. Asian regulators are voicing their concerns regarding the impact of EU financial sector policies on their continent but Africa is silent. Unintended consequences arising from foreign policy changes are dealt with by using new assessment tools to highlight problems encountered in Africa and Asia.

 

A good communications strategy or forum would assist in dealing with problems that arise from foreign policy changes. It was stressed that policy and regulatory information should be communicated clearly to stakeholders, in particular banks, because it is important to upscale and upgrade banks.

 

The BBA has been effective in intervening in instances where banks have sold insurance on misleading terms, and the Association has also looked at credit distribution (overcompensation). Pricing credit involves considering both the risk appetite of consumers and the credit cost, which are divided and added up to give a price.

1. Old Mutual

Old Mutual PLC is an investment, savings, insurance and banking group. Its headquarters are in London, but it has operations throughout the world. Its most significant business is Old Mutual Emerging Markets, which is based in South Africa (In addition, Old Mutual PLC is the largest shareholder in Nedbank). More than sixty-five per cent of the total Old Mutual PLC profit is derived from the African continent (sixty-five per cent in South Africa and five per cent from other African countries). Because the group is headquartered in the UK, Old Mutual has experience of the UK “Twin Peaks” implementation and can compare it with South Africa’s proposed reforms.  The Group is in support of South Africa’s proposed regulatory reform, emphasising the need to bring the National Credit Regulator (NCR) within the ‘Twin Peaks’ Bill in order to address persistent poor outcomes in the retail credit market.

Old Mutual has made representations on the “Twin Peaks” Bill through ASISA, the relevant industry association. 

Old Mutual highlighted the rapid growth in unsecured lending that has happened in South Africa, and the possible risks that this may create. In particular, Old Mutual highlighted the risks from fragmenting the oversight of credit providers.

For example, Old Mutual in South Africa has a credit provider licence and can do unsecured lending using that licence. In addition, Nedbank also does unsecured lending. But Old Mutual has lower regulatory requirements than Nedbank. The effect is regulatory arbitrage, and at a group level, Old Mutual is incentivised to lend through a less-regulated entity.

Old Mutual feels that some of the issues the “Twin Peaks” Bill needs to avoid include unintentionally contributing to financial exclusion, compromising the confidentially of client information, and not providing enough education to financial services users about high indebtedness and its implications.  

 

 

1. Bank of England (BOE)

The Bank of England’s mandate is set out in the Banking and Financial Services Act, 1998. The UK “Twin Peaks” model gave the BoE new statutory powers.  According to the BoE, financial stability is seen as a pre-condition of economic growth, and financial stability should be given priority. According to the BoE, the UK “Twin Peaks” model mainly resulted in the division of the previous Financial Sector Authority (FSA) into two new authorities, the PRA and the FCA.

 

Parliamentary oversight over the BoE including of the governor, who is appointed by the Chancellor of the Exchequer, is through the House of Commons Treasury Committee.  Other committees that may hold the BoE accountable are the Lord’s Economic Affairs Committee and the EU Economic Markets Committee, which keep close track of the UK and EU markets. Select Committee Chairs are not appointed by the Whip anymore, but by the Committee members based on merit. The BoE Governor appears before the Committee at least eight times a year and his parliamentary mandate is to speak to the House of Commons on behalf of the BoE, present the financial stability report and all other inflation reports, and to report on other matters of relevance including the interest rate, mortgage criteria, transparency and openness.

 

The UK “Twin Peaks” model initially established the PRA as a subsidiary of the BoE. However there are currently measures underway to instead have the PRA be a committee within BoE, similar to the Financial Policy Committee, which will ensure efficiency in governance rather than it being a completely independent body. A weekly information sheet is produced by PRA to keep the BoE well-informed and to establish good working relations.

 

The Select Committee on Treasury recently commissioned an enquiry into the currency unit and the BoE assisted the Committee in putting together the economic facts of the case. The BoE noted that the South African legislative process is similar to the UK process as politicians in the UK also scrutinise the BoE’s work and hold public or closed hearings when necessary. 

 

Sometimes parliamentary questions related to the financial sector and which are market sensitive would not be answered. Rather, the information would be shared with the Treasury Committee clerk, as a representative of the Committee. This is intended to ensure that the Committee remains well-informed while ensuring that the information remains confidential. The BoE receives advice about the drafting of their regulations and disclosure of information from its broad range of legal councils. Market sensitive information does not leave the BoE, but MPs are encouraged to use the BoE’s published information.

 

All committees within the BoE are chaired by the Governor. The FPC must conduct cost-benefit analysis and limit the number of loans that can be made (it deals with the complex trade-offs in this regard), and also recommends on the housing market, looks at the impact of competition and ensure micro-macro balance to ensure that no harm comes to the economy. The FPC might issue recommendations in a crisis, but is not the body that deals with the crisis and HM Treasury will get involved in the event of bank failure. In terms of cross-border management, the Bank believed that the HSBC is a challenge as it has the majority of assets outside the UK.   

 

 

 

 

1. Financial Conduct Authority

In the old regime, consumer credit was regulated mainly by self-regulating bodies through the Consumer Credit Act, 1974 and the Financial Services Act, 1986. Responsibility for consumer credit was then given to the Office of Fair Trade. In 2014, this responsibility was given to the newly created FCA. The FCA replaced the Financial Services Authority which had been established in 1997 as a single financial services regulator responsible for both prudential and conduct of financial firms. The FCA covers all retail financial services and its objectives include ensuring clarity, coherence and improved market oversight; effective and appropriate consumer protection; providing opportunities for simplification and de-regulation; as well as a proportionate and cost-effective regime.

 

Key challenges faced by the FCA have included a tripling of firms under supervision when it took over responsibility for consumer credit regulation (from about 25 000 to about 73 000 mostly small firms), which led to an urgent requirement to upscale systems. In addition, about 80 000 staff were transferred or freshly recruited. People had to be trained to do new jobs and about four-hundred temporary staff were recruited.  The FCA faced new reputational risks as a result of the new mandate, and had to deal with issues such as high-cost credit and greater need for debt advice and debt management.

 

In terms of the requirement for consumer credit firms with existing licences to apply for new FCA authorisation, firms did not raise any concerns related to process or principle. The FCA undertook a staggered approach to re-licensing. Even though very few firms have been refused authorisation, some raised concerns about the issue of re-authorisation, while some small firms dropped out of the process and did not apply. There were limited rules that applied when the transfer occurred and new rules were created for pay-day lenders and there was a greater focus on debt management.

 

The FCA takes a principles-based approach and the principles are set out in law. The FCA also publishes ‘best practise’ guidance and has a ‘handbook’ of rules available for financial institutions.

 

Challenges faced by the FCA include delays in authorisation decisions due to the fact that firms are not familiar with the regulatory language and therefore the Contact Centre is inundated with calls; a lack of datasets has also led to a major challenge in building up complex market information; some sectors were found to be in a worse position than was expected, including debt management and brokers; and there are still some key areas to address including a standard of credit-worthiness assessment, broker remuneration, and replacing the remainder of the Consumer Credit Act (which will be reviewed in 2019). The FSA had set up ‘shadow’ structures prior to the establishment of the FCA to manage the transition to a new organisation.

 

1. Financial Ombudsman Services

 

The UK financial sector has a single Ombudsman that was established by statute in 2000. The Ombudsman was formed by consolidation of various industries ombudsmen to form one entity. The Ombudsman is financed via levies and fines on the industry, and its decisions are binding and may only be challenged on process through a judiciary process. The Ombudsman is led by a Chief ombudsman appointed by the FCA and then ratified by the HM Treasury.

1. Money Advice Service

The Money Advice Service (MAS) was set up by government to assist highly indebted citizens with free financial education. It was previously a department of the FSA. The MAS gives free, unbiased money advice (not personal advice, rather generic financial advice or education) to help citizens make informed choices as well as coordinates efforts to improve financial capability[2] across the UK. The MAS is independent and impartial and avoids commenting on government policy changes; and much like the FCA, is funded by levies on the financial services industry. The levies are collected by the FCA as the MAS is part of the FCA family. The MAS is sponsored by the FCA to ensure financial inclusion because some aspects of the FCA’s role includes access to financial services. Parliament played a key role in ensuring that this function is included.

 

The role of the MAS is to enhance the understanding of members of the public of financial matters, to enhance the ability of members of the public to manage their own financial affairs by building up financial knowledge and capability of individuals, as well as to work with organisations that provide debt advice services to increase availability, improve quality and increase consistency. There are numerous statutory consultees on its business plan and budget. The MAS budget includes a voluntary contribution from the energy and water sectors because they do not pay levies for historical reasons, but are included due to the fact that they contribute significantly to the issues at hand. 

 

The MAS runs advocacy and outreach programmes and gives financial advice to new parents regarding financial planning for a family. These services are provided through partnerships with other organisations. In 2014/15 the MAS worked on 21 million customer contacts, 9.2 million actions were taken, there were more than 100 000 users of the pay-day loan advice tool, they launched a Retirement Advice Directory to funnel consumers to Independent Field Advisors (IFAs), and the mortgage affordability calculator was used more than half a million times.

 

The MAS sponsors a network of debt counsellors which offer free debt advice to heavily indebted people. The MAS has also increased quality by implementing a quality framework that sets out the criteria for quality advice and education, sets the qualifications for advisors, and develops a peer review scheme. The MAS seeks to enhance efficiency and effectiveness of the market by addressing market imperfections that lead to sub-optimal outcomes for consumers, firms and the economy as a whole. It also seeks to increase freedom of choice by assisting customers to engage with and maximise the benefit of financial decisions.

 

The MAS worked with an independent panel to develop a detailed picture of where the greatest dangers are for most consumers, which revealed that the greatest areas of need are efficient budgeting, savings in terms of resilience or ensuring a cash buffer in the short term, long term preparation for retirement, as well as dealing with debt problems. In terms of children and young people, the MAS indicated that it was important that financial advice be in the school curriculum. In relation to education, an incubator fund has been set up with the Education Endowment Foundation to identify interventions in schools that improve financial capability and educational attainment.

 

1. London Stock Exchange Group (MTS)

 

The London Stock Exchange Group caters for companies that fit into the fixed income of the London Stock Exchange and that own about 60 per cent of MTS equity. These include primary markets, cash equities, derivatives and fixed income. MTS deals with cash trader bonding (core business), corporate bonds (mainly runs like an equity exchange), multi-dealer-to-client cash bond trading (electronic trading system), dealer to client interest rate swap products, interdealer order book for repo contracts, real-time and historical data products, pre-trade axes aggregation tool for the buy-side, and dealer to client platform for tri-party repo contracts.

 

MTS operates in London (business development activities), Rome (Monitoring and Operation Department), Milar (Technology Department), Paris (French markets), San Francisco and New York (United States operations and business development). The “Twin Peaks” model has provided clarity in terms of how MTS should interact with the regulatory authorities. MTS‘s market relations role has been configured within the context of how market participants interact with each other and how MTS can interact with the markets. The world is moving towards a global integration and coordination of regulators and MTS relies on what their regulator has with other regulators.

 

• MTS Cash: MTS cash comprises a number of regulated and professional cash securities markets for the interdealer market place. It provides a premier trading venue that is professional, orderly and efficient; offers a wide product coverage in terms of an expanding choice of product classes and securities; seamless integration with pre- and post-trading applications; continual technological innovation and rich functionality, a complete automated settlement network; and regulated markets.
• MTS Bond Vision: this is a multi-dealer-to-client electronic bond trading venue that offers institutional investors direct access to the heart of the market’s liquidity. It connects users directly with one of the largest network of liquidity providers available on an online trading platform, thus ensuring access to the best rates available. Its benefits include provision of an independent and broker neutral, top tier market makers, optimal trading and workflow technology, extensive coverage of securities, in-depth post-trade reporting, and a wider choice of trading models.
• MTS B2SCAN: in January 2015, MTS and B2SCAN[3] entered into an alliance to enhance liquidity and efficiency for banks and the investment management community. MTS B2SCAN allows banks to facilitate trading with key clients, recycle inventory, free up the balance sheet, control who can see data and negate information leakage, as well as make more money trading their axes rather than bonds they are axed[4] on. MTS B2SCAN assists investors in finding the list of bonds that fit their criteria, total size of bonds and the banks that are axed. The tool can therefore enhance best execution and lends itself to the forthcoming UK regulations.
• MTS Repo and Agency Cash Management: MTS Repo is an order driven market delivering deep liquidity for both cash investors and specific bond traders with fully automated settlement and connectivity to clearing houses. Benefits include  deep liquidity for both cash investors and specific bond traders, extensive member and settlement network, comprehensive support for all repo contracts, a regulated market, consolidation of all trading activity into a single blotter, fully automated settlement and connectivity to clearing houses, as well as sophisticated credit-line management and intra-day credit control functionality. Agency cash management is a UK-regulated electronic platform that uses the MTS Repo technology to enable cash-rich investors to enter into secured money market investments via the tri-party repo mechanism.
• MTS Data: all data related to 18 government bond markets, over 1100 bonds, over 100 unique counterparties (all-in-all generating around 30 000 000 executable prices each day) is derived from MTS Cash. MTS Data has four products, i.e. MTS live[5] for MTS Cash participants only; MTS Real-Time[6] for the global investment community; MTS Historical[7] for central banks, researchers, investors, academics, etc., and MTS Reference prices[8] for banks, asset managers, administrators, central banks clearing houses and others.
• MTS Swaps: a dealer-to-client electronic platform for trading that offers a sponsored access model for clients permitting anonymous trading; a centralised, FCA-regulated platform; click-to-trade protocols and a liquidity pool provided by dealers supporting the platform from launch.
• MTS BondsPro: an All-to-All limit order book with click-to-trade functionality and firm pricing

 

1. LCH Clearnet

A deriviatives clearing house sits between banks and end-users of derivatives, acting as a guarantor to the financial markets with the primary function of risk management. The clearing house uses margining (i.e. it requires collateral against positions/risk) and also maintains a default fund so that in the event of a default, it has sufficient financial resources to actively run its default management process and ensure performance of the contracts of all non-defaulting members/clients. Clearing is important because defaults do happen and it is important for traders to consider their portfolios, understand the risk clearly and then go out to market and trade. Traders should try to minimise risks when they sell their portfolios.

 

In terms of process, clearing starts in the markets where traders match their trades and send them to the clearing house, which validates and registers trades, and updates member’s positions. Clearing is important in counterparty credit risk reduction, which entails reducing trading exposures to a single net amount with a counterparty of the highest quality. Counterparty risk must be mediated when people take long-term credit risks and when they trade with multiple people.

 

Clearing is also important in ensuring default protection (the clearing house underwrites all cleared transactions with a defaulting counterparty), trade certainty (trade performance is guaranteed through the default management process) and improving capital market (processing) efficiencies and delivering cost reductions (simplifying trade processing through multilateral settlement netting), reducing errors and operational risks through automated straight-through-processing, and reducing legal and regulatory complexity through standardised agreements and processes.

 

Historically, LCH Clearnet has dealt with default and risk management and they play a public role in the markets that they serve. Although the company is global with operations in Europe, the US, Canada, Australia and Japan, it is also respectful to regional and local regulations. There are different conditions and requirements in different countries, for example, Canada and Australia have licencing requirements.

 

Swapclear, a sub-division of LCH, is a global leader in interest rate Swaps (derivatives) clearing, it has robust and accurate risk management systems and has a proven default management track-record. Swapclear clears approximately 60 per cent of the total Rand Internal Revenue Service (IRS) market and 98 per cent of the cleared Rand IRS market. Parliament will consider and discuss default management when it meets with the Johannesburg Stock Exchange. The Johannesburg Stock Exchange is already concerned with systematic risk that could lead to its status as a Central Counterparty Clearing House (CCP) being eroded.

 

LCH Clearnet has been engaging with the South African market (banks, banking associations and regulators), and 5 South African banks are Swapclear clients. South Africa does not really have major bank risks or defaults, but the South African market seems to like the professionalism introduced by clearing from an economic point of view. LCH Clearnet is working toward a strategic regulatory framework that will introduce a framework for external CCPs to offer clearing services directly in South Africa. There are still some unanswered questions regarding this proposed framework, as well as concerns with the proposed timelines associated with implementation and subsequent licencing.

 

4.10 UK Parliament

 

The SCOF delegation met with Senior Officials from the House of Commons Treasury Committee, which is the equivalent an equivalent of SCOF in the UK Parliament.

 

In the UK, the introduction of a “Twin Peaks” system was notably a political one, as it had been one of the election promises of the Conservative Party ahead of the 2010 UK General Election.

 

Prior to the 2010 General Election, Parliament held hearings during the course of the crisis, from the very beginning shortly after the failure of Northern Rock, and so in the UK, change was driven by Parliament at first.

 

The series of bank failures was a major issue in the 2010 General Election. The view was that the reforms introduced by the Labour Party had not worked. In particular, the decision to introduce a single financial sector regulator outside the central bank had not been effective. This regulator, the Financial Services Authority, had arguably focussed too much on conduct issues, and not enough on prudential concerns.

 

It was notable that there is an inherent conflict between prudential supervision (the safety and soundness of an institution) and the market conduct supervision (how the institution conducts its business). Too much focus on safety and soundness can lead to institutions that are profitable and not likely to fail, but that missell to their customers. Too much focus on market conduct, can lead to the regulator forcing the institution to make unprofitable decisions, which, while they may be beneficial for customers, could put the institution into financial difficulties.

 

When the Conservative-Liberal Democrat coalition came into power in 2010, the introduction of the new framework was made a priority. The Committee took hearings from a variety of experts on what had happened in the crisis, and on the particular provisions contained in the proposed Bill.

 

As part of its work, a Joint Committee Report on the Financial Services Bill was prepared. This report set out a summary of the Inquiry that had been held, and analysed whether the proposed “Twin Peaks” reforms were appropriate in the circumstances.

 

4.11 Barclays Bank

 

Representatives of Barclays, which holds a 62% stake in ABSA, explained how Barclays had to change organisationally to comply with the new regulatory regime in the UK, particularly for conduct regulation. Barclays now has a conduct risk team focused on customer outcomes from a risk perspective. Barclays is closely monitored by the FCA, which conducted 180 visits to Barclays in 2014 alone

 

A Barclay’s representative questioned how accountable the FCA was? The PRA reported to Bank of England as well as Parliament, while the FCA accounts to Parliament directly. It is felt that the FCA is not held to account to the same level as PRA.

 

It was also said that fines levied in the UK by regulators are disproportionate, as same fines are levied regardless of the size of the bank, and therefore they impact on the revenues of banks differently. It was suggested that fines might serve as a ‘scorecard’ being used by regulators for political reasons. It was said that the “Twin Peaks” model in the UK was also driven by a political impetus. If a different party had won the 2010 elections, it is possible that the FSA would have remained.

 

The shift to “Twin Peaks” model in the UK, as suggested, was well managed. It was an easier transition for the PRA to make than the FCA – the FCA faced more public scrutiny and has more stakeholders. The quality of supervision Barclays faced from the regulators has improved as a result of the split of conduct and prudential regulation.

 

Barclays new products go to FCA before they are launched. This might imply the regulator has given at least tacit approval and carries the possible risk of regulator being held accountable for poor products – yet the regulator is not responsible for designing products. In terms of the “senior managers” regime, there is also joint responsibility between Barclays and FCA in hiring senior managers. This may carry a similar risk as product approval. It may also limit hiring discretion and innovation in hiring – for example, the requirement to have banking experience, which may not be necessary if a bank is wanting to innovate in terms of technology.

 

Banks in the UK have removed themselves from the advice space due to the regulatory burden. Barclays feels that this negatively impacts on poor customers who may not have access to advice.It was said that Barclays views the customer as central to their business, so they should not find themselves at odds with the FCA.  They supported the position that ‘conduct risk’ is not strictly defined by FCA, so they can determine what this means in context of their business and control for it accordingly.  

 

4.12 Standard Bank

 

Headquartered in South Africa, the Standard Bank Group has a presence in the UK, though this has been downscaled since 2010 and focused mainly on investment management. The Chinese bank, ICBC, also hold a 20% stake in the Group. Standard Bank feels that the UK regulators are highly competent. The PRA for example regulates the ICBC as well as other Chinese-based banks and so can identify emerging trends among similar entities. The two regulators apply different lenses when looking at business models, but in some instances there is duplication of regulatory requests and interactions, although they have tried to coordinate as much as possible. There seem to be tensions between the PRA and FCA, even if this is not openly acknowledged. In regulatory meetings with both the FCA and PRA present, the PRA dominates.

 

It was said that the regulators are still finding their feet and it will be interesting to see how they balance their regulatory interests as they become more established. It was noted for example that the “senior managers” regime in the UK was strongly led by the PRA and the FCA followed the PRA’s lead, but this may not always be the case in future.

 

4.13 Nomura

 

The Committee also met with Peter Attard Montalto, an economist at Nomura, a Japanese bank. Mr Montalto noted the deterioration in South Africa’s economy during the course of 2015, which was in his opinion due to both external and domestic factors. Particular domestic factors included the drought and electricity shortages. He highlighted the need for government to take proactive steps to reform the economy to make it more competitive and to increase economic growth.  Nomura said that their clients, who are investors, are worried about whether the country would be able to avoid downgrades by the rating agencies.

 

5. Some Lessons for South Africa

 

The UK Study Tour was intended to provide SCOF with experiences of the UK Parliament and other stakeholders regarding processing and implementation of the UK “Twin Peaks” legislation. Much of what has been covered above helps to provide a context for South Africa’s “Twin Peaks” Bill and offers lessons to SCOF in the processing of the Bill. Even where the UK context is different, there was much of value the Committee drew from by considering the differences. It is in the actual processing of the Bill by SCOF that the lessons from the UK experience will become clearer and more relevant. This section focuses on just some of the key issues that emerged from the Study Tour that the Committee will have to consider:

 

 

 

 

1. Parliamentary oversight and accountability

 

1. Parliament’s processing of the “Twin Peaks” Legislation: The UK “Twin Peaks” Bill was highly contested and the focus of considerable public attention.  While recognising the urgency of the “Twin Peaks” legislation the UK Parliament undertook a deliberate and lengthy process to finalise it. The implementation of the new financial sector regulation took effect in various stages, and this also contributed to the length of time it took the Parliament to process the Bill. According to the Parliament Treasury Committee Officials, the UK Parliament took more than a year to process the initial “Twin Peaks” Bill.

 

While SCOF needs to expeditiously process the FSR Bill, the UK experience shows how complex the legislation can be and the need to be thorough and consultative in finalising it.

 

1. The need to strengthen the oversight role of Parliament of the financial sector: The UK Parliament has a strong oversight role of the financial sector regulatory bodies.This includes through answering questions from Parliamentary Committees and the HM Treasury office and having regular meetings with the Parliamentary Committees. This is despite the fact that some of the regulators are private companies, like the FCA.

 

Parliamentary oversight is further achieved using other platforms, including regular meetings in the House of Commons where entities are requested to answer questions and provide information at the request of politicians. In addition, Members of Parliament participate in the process of appointing key executives of the entities, though they may not veto a particular appointment

 

As noted above, the BoE Governor appears before the Committee at least eight times a year and his parliamentary mandate is to speak to the House of Commons on behalf of the BoE, present the financial stability report and all other inflation reports, and to report on other matters of relevance including the interest rate, mortgage criteria, transparency and openness.

 

There is far more oversight provided for in the UK legislation than in the South African Bill. While recognising the considerable differences between the UK and South African parliaments, not least in terms of capacity, SCOF needs to consider strengthening the role of Parliament in the FSR Bill. While the South African Reserve Bank does not in practice answer to Parliament the way the BoE does in the UK, SCOF needs to consider the SARB appearing before it more regularly.

 

1. Multiple accountability channels (Parliament or Executive or Regulators): Despite legislative oversight in the financial sector being the responsibility of Parliament, the layers of accountability become onerous for stakeholders. As a result, there was a need to clearly distinguish between the accountability roles played by Parliament, the HM Treasury, and the Regulators.

 

There seems to be a reasonable degree of clarity in the respective roles of the different institutions in the FSR Bill, but SCOF needs to take into account some of the experiences of the UK system in this regard.

 

1. General Issues: Among the other issues that arose in the meeting with the Parliamentary Treasury Officials that are of relevance to SCOF’s consideration of the FSR Bill are:

 

•           THE AMBIT OF PARLIAMENT, THE EXECUTIVE AND THE REGULATORS TO MAKE REGULATORY REQUIREMENTS: In all countries, the regulator is best placed to make regulatory requirements, as they are closer to the issues at hand. However, in a constitutional democracy this can create complexity. The demarcation between Parliament, the Executive and the Regulators respective powers needs to be carefully considered.

•           THE DEFINITION OF “FINANCIAL STABILITY”: How do you define it, how do you measure it, and how do you regulate it?

•           PROCESS OF ACCOUNTABILITY OF THE REGULATORS: To ensure that they achieve their mandate, regulators are generally given substantial powers. But it is important that they are also held to account, and that there is a process to ensure that they exercise their powers in a responsible and appropriate way. Parliament plays an important role in this regard – and in the UK system, there are regular hearings on the work of the regulators.

•           APPOINTMENT OF KEY STAFF. In the UK system, Parliament can conduct hearings ahead of the appointment of key staff, but the appointment remains the prerogative of the executive.

 

1. Some Practical Challenges

 

1. A limited “Twin Peaks” Model in the UK? The UK model is not a strict “Twin Peaks” model. A focus on systemic stability seems to have been an overriding factor in setting up the new regulatory architecture. The PRA was therefore given much focused mandate, and prudentially regulates banks and insurers. The FCA however has a much broader set of responsibilities, including conduct regulation of all financial institutions and prudential regulation for all non-systemic financial institutions. The number of firms the FCA regulates from a prudential perspective actually makes it the largest prudential regulator in Europe. This approach to “Twin Peaks” carries the risk of diluting the focus on conduct regulation. The UK structure may, over the longer term, compromise the prudential and conduct framework, if the FCA is not equipped to monitor and address both prudential and conduct risk adequately.

 

But then is the South African model a strict “Twin Peaks” model after all?

 

While the system is commonly referred to as a ‘Twin Peaks’ system, it comprises more than simply two regulators. Two additional set of responsibilities and related power are created within the FSR Bill:

 

• The South African Reserve Bank’s responsibilities are extended to explicitly include financial stability, and the Reserve Bank is given additional complementary powers to monitor and respond to emerging systemic risks. Lessons from the failure of African Bank have underpinned new sections that give the Reserve Bank proactive financial stability powers; and
• The first steps are taken to improve the fragmented ombudsman system. Ombudsman provide a simple and effective way for aggrieved customers to seek redress. However, there are multiple ombuds, both statutory and voluntary. The first step in this process is to create a Chief Ombudsman, and a unified Ombudsman’s Council.

 

As noted by a participant on the study tour, South Africa’s system could perhaps be seen more as a “mountain”, “two peaks” and a “molehill”; where the mountain is the Reserve Bank with an overall systemic mandate, the two peaks are the Prudential and Financial Sector Conduct Authorities, and the molehill is the Chief Ombudsman. However, in the South African model, the market conduct supervision of credit providers is separate from the market conduct supervision of other financial institutions. This has the greatest impact on banks – which will be regulated for market conduct of credit by the National Credit Regulator; and for market conduct of other financial services by the Financial Sector Conduct Authority.

 

Summary of South African proposal

 

Regulatory bodies	Responsibilities	Section of the law
South African Reserve Bank	Systemic stability, monitoring and responding to system risks	Financial Sector Regulation Bill, chapter 2

 

Prudential Authority	Safety and soundness of individual institutions, including banks and insurers	FSRB, chapter 3
Financial Sector Conduct Authority	Ensuring the fair treatment of customers, excluding customers of credit providers	FSRB, chapter 4
National Credit Regulator	Fair treatment of customers of credit providers	National Credit Act, FSRB chapter 5 creates coordination framework
Chief Ombudsman	Coordinates work of ombudsman	FSRB

 

1. Clear segregation of duties for regulators: The UK “Twin Peaks” model provides for Conduct and Prudential Authority responsibilities, however, in the early implementation phase, there are at times conflicts between the PRA and FCA in their understanding of what their precise roles are and how they should be fulfilled. The conflicts may partly stem from the fact that the PRA may veto FCA decisions. According to both authorities, such conflicts are to be expected given that the regulators are still “finding their feet” in a process of re-establishing themselves after functional restructuring. But it was stressed that in developing a new policy and legislation it is important that conflicts in roles should be anticipated to ensure that they are better managed.

 

SCOF needs to ensure that these conflicts in roles are minimised in the FSR Bill. While legislation can help in this regard, the oversight of the Committee and NT will also be crucial in this regard.

 

1. Fees are borne by the Sector: According to various UK financial sector stakeholders, the reform of the financial sector was welcomed, however the costs of the reform were high. Some of the financial institutions were already fined by either the EU Regulators or US Regulators or both for their role in the 2008 global financial crisis. Any further costs would, they argued, affect their ability to contribute to the economy. It seems that a significant part of the costs of the new system is being borne by the consumers.

 

Given the lower levels of incomes and the material inequalities in South Africa, SCOF needs to be much more concerned than even the UK parliament about this.

 

1. Financial education of the public: The UK has a broad range of consumer protection bodies which inform the public about their rights and responsibilities in the financial sector. Some of these consumer protection bodies are funded from public finances, in return they play an important role in educating the consumers on financial products and services and the sector as a whole. Other consumer bodies are not publicly funded but funded by levies and fines, and they educate the financial sector service users and the public at large about the financial regulations.

 

This need for financial education of the public is even more crucial in South Africa, and SCOF needs to give concerted attention to this.

 

1. Effects of Financial Service Ombudsman: The UK has a legislated Ombudsman who protects the financial sector services users and general consumers from unfair treatment by financial service providers. The Ombudsman office is financed by levies and fines imposed on financial service institutions guilty of wrong doings. The UK’s Ombudsman has been in place for more than fifteen years and is seen to be playing an important mediatory role between service providers and users. The Ombudsman’s decisions are binding and only the procedure on its decision could be judicially challenged. The role of the Ombudsman has become more important in recent years due to the effect of the 2008 global financial crisis, which left the consumers more vulnerable to financial sector services providers.

 

The ombudsman system in South Africa is comprised of six different ombuds – two statutory ombuds set up by law as public entities, and four non-statutory ombuds established by industry initiative. The FSR Bill attempts to begin streamlining this system by introducing a strong oversight body, reporting to the Minister of Finance, to coordinate and harmonise the actions of the ombuds, and increase customer awareness of the system. Consideration will need to be given to whether this approach is the most effective, and what further actions may be required to strengthen the ombuds system.  The relationship between the ombuds system and the court system may also need to be clarified.

1. Interpretation of the legislation: Legislation is subjected to various interpretations, and the UK’s Financial Sector Regulation is intended to limit different interpretations. However the UK “Twin Peaks” legislation makes provisions for the courts to be the main interpreter in cases of disputes between the Regulator and the financial Institutions.

 

The FSR Bill provides for the establishment of a specialised Financial Services Tribunal to act as an independent arbiter in matters of dispute between financial institutions and the regulators. This is important as an accountability measure, given the powers of the new regulators established. This is also intended to resolve issues in a speedy and efficient manner where possible, without needing to approach the courts, which can often take longer to resolve matters and where there is not necessarily expertise related to the financial sector. Importantly the Tribunal does not replace the court system and further recourse to the courts is still available.

 

1. Merger of Credit and Conduct Regulator: The credit and conduct regulation is a responsibility of the FCA in the UK financial sector. According to the FCA, in the current regulation regime, there are challenges with regards to having both the credit and conduct authority under one roof, especially due to the increase in number of institutions under its supervision,  however, it is better than having separate institutions to avoid a duplication of work.

 

In South Africa, the role of the National Credit Regulator and its location in the Department of Industry raises some challenges and will have to be addressed, in consultation with the Trade and Industry Portfolio Committee and Department of Trade and Industry.

 

The “Twin Peaks” reforms aim to reduce regulatory fragmentation which allows for arbitrage and poor customer outcomes. A single regulatory view of all activities of a financial institution (including credit) is important to ensure all risks are identified. The FSR Bill attempts to harmonise the approach to credit regulation, including by providing strong cooperation mechanisms between the NCR and FSCA. It is important to consider whether such measures are adequate. 

 

1. Potential and Unintended Outcomes

1. Balance between economic growth, regulations and job creation: One of the key lessons from the UK authorities is that the legislatures need to manage competing policy objectives better. The UK “Twin Peaks” legislation was mainly motivated by the 2008 global financial crisis, however, some of the measures imposed on the financial sector were later seen to impede economic growth. In acknowledging this, the UK Parliament, Government and Regulatory bodies agreed to propose changes to the then implemented ”Twin Peaks” model to enable economic growth. These proposals were done in consultation with the sector players. Some of the financial providers, however, argue that the current financial regulations make it difficult for them to provide debt and other services needed by the economy.

 

Similar challenges need to be considered in the South African context. The SCOF needs to ensure that the FSR Bill does not serve to further exclude the poor and disadvantaged from the financial system and that the stricter regulatory requirements do not unnecessarily impede economic growth    

 

1. Market access by small players: Some of the arguments about the causes of the 2008 global financial crisis include concerns that some of the financial institutions were too big and their failures had devastating consequences on other players in the market. The UK ”Twin Peaks” model is also aimed at significantly reducing conduct that could lead to big institutions failure. It is also intended to ensure that the financial sector is accessible to small institutions. It is unclear whether this was achieved since the introduction of financial reforms in the UK.   

 

Given that the four major banks have about 90% of the market share, this is a very important consideration in the South African context.

 

1. Consumers may bear a disproportionate share of the cost of the reform: The UK financial services consumers are thought to be bearing a disproportionate share of the costs associated with reforming the sector. It is arguably inevitable that the part of the cost of the reform will be borne by the consumers, however, there should at least be a proportionate cost allocation between consumers and the industry.

 

This is an even more important consideration in the South African context, given the higher proportion of the population in this country who are poor and disadvantaged and the significant profits made in the South African financial sector   

 

1. Concluding Remarks

The Study Tour was certainly interesting, fascinating, rewarding; it turned out to be even more successful than was anticipated. Even where the context and aspects of the financial system are different in the UK, there were many valuable lessons for the processing of the proposed South African “Twin Peaks” model. Just how useful the Study Tour was will become even more obvious as SCOF processes the FSR Bill from August this year.

The Committee expresses its sincere appreciation to our hosts in the UK who were very accommodating and extremely helpful. The Committee also thanks all those on the South African side who assisted in putting together such a good programme.     

 

Report to be considered.

 

 

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