18 June 2002

FINANCIAL SERVICES BOARD PRESENTATION TO THE NATIONAL COUNCIL OF PROVINCES ON THE FINANCIAL ADVISORY AND INTERMEDIARY SERVICES BILL, 2001

(B52 2001) (the Bill / the FAIS Bill)

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  1. BACKGROUND
    1. Consumer protection lies at the root of this proposed legislation.
    2. Unlike the situation in comparable jurisdictions, in South Africa there is almost no law regulating financial intermediaries.
    3. There has been a long felt need for such regulation as confirmed by the findings of the Commission of Inquiry into the Affairs of the Masterbond Group and Investor Protection in South Africa (October 2001).

(d) The task of conceptualising and designing appropriate legislation to cover this regulatory deficiency was accepted by the Policy Board for Financial Services and Regulation (the Policy Board) in 1996. After several meetings and workshops the Policy Board in December 1998 produced a basic framework for this law.

2. POLICY BOARD FRAMEWORK

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

3. CHANGES TO THE ORIGINAL CONCEPT

    1. As could be expected with comprehensive legislation in an area hitherto not regulated, it soon became apparent that the original concept for this law needed to be re-visited. In fact the pattern of reviewing was repeated as the drafting of the law proceeded and as it became exposed to public scrutiny and comment.
    2. Very early the rationale for limiting the ambit of the law to Ainvestment products, including insurance products with an investment component@ and the exclusion of advice in respect of bank deposits, came to be questioned. The result of the debates which ensued was that the range of financial products which were to be defined in the Bill was expanded significantly to cover most financial products and instruments, including bank deposits.
    3. A major revision of the ambit of the Bill came about after the second draft of the Bill had been work-shopped and commented upon by a large number of interested parties. The FSB came to realise that if the ambit of the Bill was to be confined to financial advice giving, a large number of intermediaries actually engaged in the insurance and investment sectors of the financial services industry, would escape the regulatory net.
    4. To overcome this gap the terms of the Bill were expanded to include "intermediary services" in addition to the furnishing of "advice". This extension resulted in the activities of investment managers, hitherto regulated under financial markets legislation, being brought under the jurisdiction of this new law. With the wide definition of "intermediary services@, there can no longer be any doubt that the activities of the entire broker fraternity in both the long-term and the short-term insurance industries, as well as those of portfolio or fund managers, are squarely covered by the provisions of the Bill.
    5. The changes to the FAIS Bill from the original framework set by the Policy Board were fully motivated to and accepted by the re-constituted Policy Board on 18 February 2000.

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

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

"Financial service" means any one of these services and a "financial services provider" means a person who as part of a regular business renders any one of these services.

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

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

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

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

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

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

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

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

6. METHODS OF REGULATION

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

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

7. GENERAL SCHEME AND FEATURES OF THE BILL

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

    1. There will also be an Advisory Committee (representative of industry and consumers) with whom the Registrar must consult on all important issues (clause 5).
    2. The registrar may delegate his powers, inter alia, to "any body recognised by the Board@ (FSB) (clause 6(3)(a)(iii). This creates the opportunity for the FSB to administer the law in conjunction with recognised industry bodies which could (e.g.) assist with the licensing process, enforcement of codes, compliance related matters, etc.
    3. An outstanding feature of the Bill is its flexibility of application. This will enable the regulator to rectify unintended consequences, to address cases of hardship, to ensure pragmatism in the application of the Act. A few examples may illustrate this point -

8. EXEMPTIONS

    1. The Bill itself provides for the exemption of certain persons from its provisions. These may be divided into two categories (clause 45(1)(a) and (b)).
    2. The first category are persons or entities who are members of self-regulatory bodies (the financial exchanges) or where activities are regulated elsewhere (collective investment schemes management companies and pension fund and medical scheme administrators).
    3. The exemption is stated to be "to the extent that the rendering of financial services is regulated by or under" the Acts referred to in clause 45(1)(a).
    4. The second category of persons exempted are executors of deceased estates, curators, liquidators, trustees of non-business trusts and guardians of minors.
    5. In the latter case the exemption is also qualified if these persons render the "financial service@ as a regular feature of their business, the exemption will not apply (clause 45(1)(b)).
    6. The motivation for these exemptions is, in the first instance, that the activities are sufficiently regulated elsewhere; and, in the second instance, that the Bill does not wish to interfere in activities outside the financial services industry.

9. REPEAL OF LAWS

    1. In the Gazetted version of the Bill, the repeals were two-fold: to make provision for the transfer of the supervision of investment (fund/portfolio) managers from the Stock Exchanges Control Act, 1985, and the Financial Markets Control Act, 1989, to this Act; to repeal the Policyholder Protection Rules (Long-term and Short-term) "insofar as it relates to the rendering of financial services as contemplated in this Act.@
    2. In the present amended version of the Bill, the repeal of the Policyholder Protection Rules has been deleted so that these Rules are no longer repealed. However, a new clause 44(5) has been inserted to provide for the interaction between the provisions of the FAIS Bill and the Policyholder Protection Rules so as to prevent dual regulation. This will be dealt with in more detail hereafter.

10. EARLIER CONTROVERSIES WHICH HAVE BEEN RESOLVED

(a) Banks

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

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

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

(iv) In order to accommodate the banking industry, in the Gazetted version of the Bill, advice by a bank on its own deposits was excluded from the definition of "advice@. However, during the hearings before the Portfolio Committee on Finance, this concession to banks was somewhat tempered. The latest amended draft of the Bill draws a distinction between a bank deposit not exceeding a term of twelve months and a bank deposit exceeding a term of twelve months. The latter deposit is dealt with as an investment product and financial services relating to such deposits are subject to the full impact of the provisions of the Bill and its subordinate legislation, such as the General Code of Conduct.

(v) In the case of short-term deposits, namely those with the term not exceeding twelve months, a financial service by a bank or a mutual bank in respect of such deposits will only be regulated to the extent provided in a Specific Code of Conduct which will deal with this activity (clause 1(4) read with clause 15(2)(b) of the Bill).

(vi) The previous controversy concerning bank deposits has accordingly been resolved in the aforegoing manner and this has been accepted by all commentators including the Banking Council.

(b) The Constitutionality of the Office of the Ombud for Financial Services Providers

(i) The establishment of this office and the function of the Ombud are provided for in Chapter VI Part I of the Bill (clause 20 onwards). This office will deal with client complaints against financial services providers and their representatives and is expected to be the most important law enforcement mechanism created by the Bill.

(ii) During the deliberation before the Portfolio Committee on Finance, two commentators, relying on legal opinion, submitted that the office and activities of the Ombud, as proposed in the Gazetted version of the Bill, would be unable to sustain constitutional challenge.

(iii) The provisions in question were thereafter extensively revised and although no principle amendments were effected, the concerns of the said commentators were addressed. The amendments all relate to the institutional independence of the Ombud. It is respectfully submitted that the present draft of the Bill is such as would render the FAIS Ombud clear of constitutional muster. This view is supported by the Parliamentary and State Law Advisers whose proposals in this regard have also been accepted.

(c) Interaction between FAIS and the Policyholder Protection Rules (PPR)

(i) As stated earlier in this submission, the Gazetted version of the Bill provided for the repeal of the PPR insofar as they relate to the rendering of financial services. This wording was criticized by some commentators, notably the Life Offices Association (LOA), as being uncertain and the FSB as promoters of the Bill were required to spell out in more detail what specific parts of the PPR would be repealed and what part of them would remain.

(ii) After further consideration and debates before the Portfolio Committee on Finance, the FSB proposed to deal with the interaction between FAIS and the PPR as stated in clause 44(5) of the present version of the Bill. This provision enables the Minister by notice in the Gazette to exempt a financial services provider or representative from any provision of the two sets of PPR promulgated under the relevant sections of the two Insurance Acts. The new provision has been sanctioned and approved by the Portfolio Committee on Finance and this fact has been accepted by the LOA. A draft notice in terms of clause 44(5) has already been prepared and is presently subject to consultation and the concern of dual regulation has suitably been addressed.

(iii) Whatever controversy may have existed on the interaction between the provisions of the FAIS Bill and the PPR has, therefore, been resolved.

(d) Health Brokers

(i) In the Gazetted version of the bill provision was made for the exemption of health brokers who are accredited in terms of section 65 of the Medical Schemes Act, 1998.

(ii) This proposed exemption was met with severe criticism from all commentators, in particular in the long-term and short-term insurance industry and consumer bodies, and was labelled "regulatory non-sensical". Having reconsidered the matter and arguments against the exemption of health brokers, the FSB, prior to the submission of the Bill to the Portfolio Committee on Finance, effected an amendment which had the result of including health brokers within the ambit of the Bill. This reversal on the earlier position was rejected by the Council for Medical Schemes who saw it as an intrusion into their regulatory territory. Representations on behalf of the Council for Medical Schemes were also submitted to the Portfolio Committee supported by motivations from the Ministry of Health.

(iii) After a delay of some months in the progression of the FAIS Bill, the impasse was resolved by means of an agreement between the Financial Services Board and the Council for Medical Schemes. Legislative effect to the agreement was given through the introduction of a new clause 8(7) into the FAIS Bill and the simultaneous amendment of the Medical Schemes Act. The draft Amendment Bill has already been prepared and published and the intention is to promulgate the Amendment Bill to coincide with the coming into effect of the FAIS Bill.

(iv) The essential element of the agreement concluded is that, whilst health brokers will have to be accredited under the Medical Schemes Act, they will, like all other intermediaries, be subject to the common framework provided by the FAIS Bill, including its subordinate legislation, thereby establishing an integrated approach to market conduct regulation.

(v) The vexed question concerning the position of health brokers has accordingly been resolved to the satisfaction of all parties.

11. SUBORDINATE LEGISLATION

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

(b) The Bill itself has had a history of public consultation over a period of more than three years. During this process much of what is or will be contained in the subordinate legislation was discussed, canvassed and thrashed in public and private discussions, workshops, comment and other communications.

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

(d) By August 2001, six pieces of the more important draft subordinate legislation had been produced and publicised on a limited basis. At this point, thirteen pieces of draft subordinate legislation have been prepared and, after an extensive consultative process, revised and publicised. The closing date for enquiries concerning the draft legislation is 15 July 2002 whereafter all subordinate legislation will be finalised and published.

12. COST EFFECTIVENESS

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

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

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

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

(e) As a matter of prudence the FSB nonetheless has caused a professional cost-benefit analysis to be prepared of this Bill. A report by the consultants is available should the Select Committee wish to have sight of its contents. Suffice it to say that the findings of the consultants were favourable.

13. CONCLUSION

The amended FAIS Bill presently presented to the Select Committee, is the final product of intensive deliberations during the consultative process and during the Parliamentary debates. Support for the Bill has been expressed by all major industry players, consumer organisations, governmental institutions and regulators. No contentious issue remains unresolved. It is submitted that a sound case has been made out for the adoption of the Bill (as amended) in the interest of consumer protection.

 

LEGAL DEPARTMENT

FINANCIAL SERVICES BOARD

14 June 2002

ATTACHMENT A

 

FINANCIAL ADVISORY AND INTERMEDIARY

SERVICES BILL, 2001 (FAIS)

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RATIONALE, OBJECTIVES AND ELEMENTS OF THIS LEGISLATION AS ORIGINALLY PERCEIVED BY THE POLICY BOARD FOR FINANCIAL SERVICES AND REGULATION (DECEMBER 1998)

(BRIEF SUMMARY OF DISCUSSIONS AT WORKSHOP)

Introduction

The basic assumption was that the regulation of financial advisers was necessary in order to compensate for market failures and regulatory failure by the State. In looking at market failure, within the context of financial advice, an asymmetrical flow of information in the market was identified as the main reason for market failure and it meant that the suppliers of financial products and/or the advisers had more information than the buyers of the products. Market failures as a result of asymmetrical information flows were usually addressed by the adoption of rules for market conduct, including:

Consumer/investor protection and education

Investor protection was reconfirmed as the main objective of the intended regulation of financial advisers. General agreement was reached that the focus of the regulation would only be on advice in respect of investment products, including insurance products with an investment component. It was accepted that the intended regulation had to be supplemented by the education of investors and advisers. Financial product suppliers and intermediary firms should be involved in the education process, but part of the responsibility for education had to be accepted by the statutory regulators.

Points raised in a discussion of elements of the intended regulation of advisers

3.1 Scope and intensity of regulation

In terms of the modular approach to consumer protection, referred to previously, and the specific focus of the intended regulation on investment and insurance advice, it would be necessary to focus on the investment area. Advice in respect of debt instruments, mainly bank deposits, had to stay outside the envisaged regulatory net and should be addressed largely through banking regulation.

The general conclusion about the scope and intensity of regulation was that the focus of the regulation would be on advice in respect of investment products, including insurance products with an investment component, and that high-intensity regulation should be considered in the case of more sophisticated products based on long-term contracts.

3.2 Entry requirements and professionalism of advisers

The general conclusion was that competency requirements and the training of advisers and marketers of financial products were necessary in order to establish a professional group of service providers in South Africa. Because of the variation in investment services providers, in terms of standardised as well as sophisticated products, differentiation in the required competencies of advisers was warranted.

3.3 Standards for the market-conduct of advisers

Although no explicit comprehensive conclusion was reached at the workshop on standards of market conduct for advisers, there was general agreement on the need for standards or a code of conduct for advisers. Important standards or elements of a code of conduct related to the

 

 

4. Responsibilities of financial product suppliers

The general view of participants in the workshop was that the main focus of the intended regulation would be on advisers in order to achieve the objective of investor protection. This approach, however, would not rule out the assignment of responsibility to product suppliers.

5. Cost of regulation

Experience indicated that in the medium to long term the implicit cost of not having investor protection was far higher than the explicit cost of investor protection through regulation. It was necessary to look at regulatory costs from different angles. Direct and quantifiable regulatory or supervisory costs should be weighed up against unquantifiable costs in the form of losses incurred by investors through lapses and surrenders of investment contracts.

A cost-benefit analysis done in the United Kingdom indicated that the benefits of regulation far outweighed the costs of regulation because investors became better educated. Not only did this result in more informed investment decisions, but the services required by investors became better defined and, accordingly, the cost of services declined.

Some concern was expressed that investment service providers would have to bear the cost of regulation, whereas it could have been linked to the financial product supplier or the investor. It was mentioned that research had shown that the sellers of financial products were ultimately content to bear the cost of selling products.

Although no firm conclusion was reached, the discussions indicated that the consumer/investor was likely to bear most of the cost of regulation - a price to be paid for better protection, education and a consumer/investor knowledge base. Further benefits to be derived would be a better understanding of investor needs, the offering of more appropriate financial products and more informed investment decisions.

  1. General conclusions

Main general conclusions

There was general agreement on the need for enhanced consumer protection and what this would entail. Consumer, and more specifically investor, protection could be achieved by implementing an appropriate combination of the proposals submitted previously and discussed during the workshop. The intended regulation should have clear statutory backing and there would be statutory sanctions for non-compliance with statutory requirements.

With reference to the points made and conclusions reached in the discussions at the workshop, there seemed to be general agreement on the following:

    1. The authorisation or licensing of product suppliers and intermediary firms which acted as principals in the provision of investment advice, as well as of individuals acting as advisers.
    2. Competency requirements and the training of advisers and marketers of financial products were necessary in order to establish a professional group of advisers. Differentiation in the required competency standards for advisers was warranted.
    3. Entry requirements for advisers were necessary and could be linked to authorisation or licensing. Competency requirements would be part of entry requirements.
    4. A register of their employees and representatives should be maintained by product suppliers and intermediary firms in order to facilitate the training of advisers, the monitoring of their market conduct and the taking of appropriate action in cases of non-compliance. A majority opinion seemed to favour a central register.
    5. A code of conduct with statutory backing, to govern the market operations of advisers was generally accepted. The code would provide, inter alia, for:

 

(f) The monitoring of the fitness and propriety of advisers and their compliance with market-conduct requirements by compliance officers.

(g) Appropriate recourse for investors to product suppliers and intermediary firms, as represented by their compliance officers, to ombudsmen, a review panel and courts of law.

(h) Sanctions for non-compliance with requirements and rules.

(i) Regulation in the form of a combination of market-conduct requirements, reliance on the reputation of product suppliers and intermediary firms, and statutory regulation.

(j) In terms of this approach the statutory authority would be responsible for the

(k) Product suppliers and intermediary firms would be responsible for the:

(l) Regulatory costs were regarded as inevitable and likely to be borne by investors, but costs should be weighed up against investor benefits flowing from regulation.

The emphasis in enforcement should initially fall on how non-compliance should be dealt with instead of on the detailed monitoring of advisers. Critical issues in enforcement would be adherence to the intended code of market conduct and the monitoring of compliance, mainly by compliance officers.

The intended regulation could begin the process of achieving broad consumer protection in South Africa. It would cover one particular gap in consumer protection and demonstrate that something was being done about the matter. The gap that remained was the lack of education and awareness on the part of consumers. This gap had to be closed eventually in order to establish the desired knowledge base.