Twin Peaks is now a reality

Now that the FSR Act is approved, the envisioned Twin Peaks architecture is now a reality but what does that mean for regulated entities and when will the changes start to be felt?

The FSR Act

The FSR Act not only designs the architecture for supervising the financial sector but also shifts the approach and mandate of the conduct authority which essentially amounts to an overhaul of the regulatory approach.

FSR Act introduces the Prudential Authority (PA) under the South African Reserve Bank (SARB) and determines that the FSB will become a dedicated market conduct supervisor over all financial institutions. The first change that will be seen or felt by the sector will be in the Insurance space. All of the staff in the current Insurance Prudential Department will move to the SARB in October. They will still report to the FSB and fall under Caroline Da Silva who is the acting Deputy Executive Officer for Insurance at the FSB. They will continue to report to the FSB under the current Long-term and Short-term Insurance Acts until the PA goes live which is anticipated to be at the end of the 1st quarter of 2018. Insurance Bill is the law that will govern the prudential aspects of insurance and this is currently going through the Parliamentary processes. As soon as this Bill is promulgated all insurers will be subject to this Act for prudential purposes.

They will also however be subject to the current Long-term and Short-term Insurance Acts as amended by the FSR Act and the Insurance Bill for market conduct purposes.

In other words, what will remain with the FSB and the future FSCA is the market conduct aspects of the current Insurance legislation. This includes the Policyholder Protection Rules, which are in the process of being significantly strengthened. This means that insurers will essentially be subject to two supervisors as soon as the PA goes live and will be subject to two sets of law, prudential and separate market conduct standards.

The FSR Act also makes consequential amendments to all sectoral laws to align them with the market conduct approach and empowers the FSCA to draft standards for conduct in addition to its market conduct rule-making powers under existing sector specific laws or where no such specific sectoral market conduct law exists such as for Banking. So, after the FSCA goes live all institutions currently regulated by the FSB will still be subject to the same sectoral laws, as amended by the FSR Act, as well as potential new conduct standards that may be developed under the FSR Act. The FSR Act will therefore operate as an “overlay” over the existing sectoral laws. This status quo will remain until such time that the Conduct of Financial Institutions Act (COFI) is in place and all current licenses are converted to a market conduct license.

From a market conduct perspective, COFI will be a risk based and proportionate piece of market conduct law. This means that when the FSCA sets conduct standards under COFI, it will take into consideration the regulatory and compliance burden on small institutions which do not pose significant risk to customers, while at the same time ensuring that those institutions which do pose significant risk are subject to more intrusive supervision. This should provide some alleviation for small organisations with regard to regulatory complexity but not from their duty to treat customers fairly. The Treating Customers Fairly (TCF) principles will be embedded into the COFI law and the FSCA’s approach will require that financial institutions are able to demonstrate delivery of fair outcomes for financial customers, rather than just ticking a compliance box.

Cost implications

While implementing the Twin Peaks model will have cost implications, Da Silva believes that from a market conduct perspective these costs will be appropriate compared to the size of the financial sector’s assets and revenues. The extension of the jurisdiction of the FSCA to all financial institutions including banking, and aspects of the conduct of certain credit providers, means that these institutions will pick up the appropriate portion of these additional costs where resourcing is required to enable their supervision. Over and above the extension of jurisdiction, the proactive, risk-based and outcomes-focused approach to regulation and supervision under Twin Peaks will require some different skills at the FSCA which implies additional costs. These include strong research skills, data analytic capability, Fintech capability and the use of Fintech to supervise and regulate just as a few examples. These initial costs however should be justified over time by greater efficiencies and embedment of appropriate risk based supervision, which for many will result in an alleviation of costs but not responsibility.