While financial markets in South Africa are already considered among the best-regulated in the world, the system is about to undergo some significant changes as the country transitions to a “twin peaks” model of oversight. The new framework will split regulation into two distinct areas, prudential and market conduct, the former concerned with solvency and liquidity of financial institutions, while the latter is focused on consumer protection. Although some questions remain as to the details of the implementation, market participants have broadly welcomed the initiative.

Current System

Over the past 15 years, the Johannesburg Stock Exchange (JSE) has led the drive to enhance its own regulatory environment, transitioning from a local exchange known for insider trading and opaque processes to the modern, transparent bourse that it is today. Acting as the frontline regulator, the JSE sets listing requirements and enforces the trading rules that it has established. According to the World Economic Forum’s Global Competitiveness Report for 2012-2013, South Africa ranked first in the world in terms of regulation of securities exchange. This was the third consecutive year that the nation achieved this ranking. However, it does not have the means to pursue infringements beyond rescinding trading rights, and, at present, the Financial Services Board (FSB) acts as the ultimate regulator. Still, limits on regulation are regarded by some as important and desirable.

Ann Mackeurtan, the managing director of Imara, a pan-African investment services firm, told OBG, “Mounting regulation is creating problems for smaller financial firms, and the rising costs of compliance is causing concern for all stakeholders.”

Companies that list on the JSE are required to be in compliance with certain aspects of the King Code of Governance, South Africa’s version of corporate governance rules. The latest iteration of the code – known as King III – was developed in part as a response to the 2008 global financial crisis and released in 2009. “Most of the listed companies are in compliance,” Norman Muller, the head of the capital markets department at FSB, told OBG. “Moreover, the registrar requires all annual reports to include details of how the firm plans to implement the King III code.”

Among the changes introduced by King III is the principle of integrated reporting, which ensures that companies issue an annual report that provides a complete picture of a business (including any subsidiaries and holding group structure), both in financial and non-financial terms. To do this, the code recommends that “reporting should be integrated across all areas of performance, reflecting the choices made in the strategic decisions adopted by the board, and should include reporting in the triple context of economic, social and environmental issues.” At the same time, the FSB and the treasury are reviewing the role of company registrars and ombudsmen in an effort to align with the push for integrated reporting. In theory, the higher levels of disclosure required by King III will provide shareholders more oversight in management decisions, which in turn should give the South African markets an advantage over their emerging market competitors.

Twin Peaks

The move to a twin peaks institutional set-up was endorsed by the cabinet in July 2011. With a discussion paper released by the treasury in February 2013 detailing the transition under the proposed reforms, the aim is to present legislation to parliament later in the year. Central among the changes will be bringing regulatory oversight of all financial services – from banking to insurance and investment – under two institutions, the South Africa Reserve Bank (SARB) and the FSB. The former will handle prudential regulation while the latter will provide market conduct oversight.

“The objective of the prudential regulator will be to maintain and enhance the safety and soundness of regulated financial institutions,” the treasury noted in its discussion paper, while “the market conduct regulator’s objective will be to protect consumers of financial services and promote confidence in the South African financial system.” These two areas can be seen as interrelated, but the latter is probably of more importance to the retail investor, Dube Tshidi, the executive officer of the FSB, told OBG. “While the financial soundness of institutions is indirectly a part of consumer protection, the man on the street is only concerned with how they are treated by these institutions,” he said.

Under the new system, the SARB will take over some activities currently handled by the FSB and will gain some 10-60 staff from the latter. The central bank will continue to maintain financial stability and enforce standards such as capital adequacy, but it will do so for insurers and other financial intermediaries, in addition to banks. The SARB will also be involved in approval of the JSE’s prudential rules and its clearing and settlement functions, and it has gained new powers over financial market infrastructure, including exchanges, the central securities depository Strate and clearing houses. TOO MUCH?: While there was initially some concern that the JSE would have to report to two regulators, this issue seems to have been resolved, with the FSB remaining the primary regulator of the JSE. “Twin peaks should not affect JSE’s role as a frontline regulator, but it may affect the reporting and oversight structure of the JSE,” Siobhan Cleary, the director of strategy and public policy at the JSE, told OBG. “We are pleased, however, that it seems that the principle of lead regulator will be enshrined, which will avoid duplication of oversight.”

More generally, the expectation is for improved communication among regulators once the twin peaks model is in place. “The eventual shift to twin peaks is encouraging inasmuch as it will bring better coordination of the various regulatory authorities, which at present are under different institutions, including the Department of Trade and Industry, the FSB, the SARB, the treasury and others,” Cas Coovadia, a managing director at the Banking Association of South Africa, told OBG. While market participants seem to broadly agree with the new framework, concern has focused on the transition phase and challenges of adapting reporting requirements for market players. Investors have also fretted about higher costs of compliance in the new environment, arguing that gains in oversight may happen at the expense of improving access to financial services. “Regulation for the sake of regulation can never be good thing. It is a double-edged sword: it increases the burden and cost of compliance with no additional benefit to the average person,” Mahesh Cooper, the director of institutional business at Allan Gray, a local asset management firm, told OBG. However, the treasury expects stricter oversight of all financial sectors’ conduct, and consumers’ rights will bolster the appeal and performance of the industry for the retail market.

Financial Markets Act

The legal basis for the twin peaks model of regulation is the Financial Markets Act (FMA), legislation that has been developed over the past few years and approved by parliament in 2012. Signed into law by the president in February 2013, the FMA will replace the 2004 Securities Act and is expected to be central to improving risk management, transparency and financial stability. While detailed additional legislation – such as that covering twin peaks – will need passage by parliament, the Act provides the legal framework for such developments. The law balances requirements for stricter oversight and preservation of the confidentiality of information, as well as clearly defining the roles and responsibilities of securities owners, users, nominees, third parties and elements of the trading infrastructure such as trade repositories. The Act also introduces new defences for dealing with market abuses such as insider trading, while specifying business rescue parameters, all in line with the reforms that were recommended by the G20 in the wake of the global financial crisis. In addition, it provides new definitions of international players, authorising remote membership for market participants without a physical presence in South Africa and identifying foreign central securities repositories for handling such transactions.

The FMA enshrines the FSB’s role as lead regulator, but it provides for exchange of information between the SARB, the FSB and the treasury. Recognising the principle of self-regulation for stock exchanges, securities depositories and clearing houses, the Act aligns fit-and-proper tests with the requirements of the 2008 Companies Act. “The more you internalise compliance, the less you will see of me as a regulator, and the lower your regulatory burden will become,” Tshidi told OBG.

Planned reforms for the South African financial system are extensive, but the regulator has emphasised the gradual nature of implementation. Building on a strong foundation, the new regulations will bring domestic markets up to international best practices. Yet in parallel to the oversight reforms, the government aims to push ahead with policies that expand access to financial services and insure fairness of both products and trading systems for the end consumer. These include the Financial Sector Code, meant to broaden inclusion, to rules like “Treating Customers Fairly”, which seek to ensure fairness in the design, marketing and service of financial products like insurance. The key to attaining such goals is balancing the cost of compliance with making financial services suitable and affordable to clients.