The Financial Sector Regulation Bill, 2015 and the regulation of financial conglomerates

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By Francisco Khoza, partner, and Thulani Dyasi, associate, Banking and Financial Services Regulatory, Bowmans

The latest draft of the Financial Sector Regulation Bill was published by the National Treasury (Treasury) on 21 October 2016. Among other things, the Bill seeks to more closely supervise “eligible financial institutions” that are part of “financial conglomerates”. To that end, the purposes of the Bill include establishing a system of financial regulation by creating the Prudential Authority (as defined in the Bill); and the supervision of financial conglomerates in relation to eligible financial institutions that are part of financial conglomerates.

The Prudential Authority is a regulator that operates within the administration of the South African Reserve Bank (SARB). The objectives of the Prudential Authority include assisting to ensure and maintain South Africa’s financial stability. The reason why the Prudential Authority is housed within the SARB is because the Bill tasks the SARB with protecting and enhancing South Africa’s financial stability, and restoring or maintaining ‘financial stability’ if a ‘systemic event’ has occurred or is imminent.

Once the Bill is enacted, the Prudential Authority (and therefore the SARB) will have the power to more closely scrutinize the internal operations of a financial conglomerate. This power will include imposing reporting requirements on information about companies within the financial conglomerate even if they are not financial institutions regulated in terms of South African law.

This will have an effect on banks in particular. The definition of “eligible financial institutions” includes a bank licensed in terms of the Banks Act, 1990 (Banks Act), and would also include foreign banks.

In terms of the Banks Act, foreign banks may, with prior approval from the SARB, conduct the business of a bank by means of a branch in South Africa. The Banks Act regulates branches of foreign banks in the same way as South African banks are regulated. In essence, the branch of a foreign bank, together with its holding company and other members of its group of companies, may be designated as a ‘financial conglomerate’ as contemplated in the Bill. As a result, they will all be more closely regulated by the Prudential Authority.

If the Bill is passed into law, holding companies of foreign banks may be required to provide the Prudential Authority with information on its subsidiaries – even if the subsidiaries do not operate in South Africa and are not financial institutions sought to be regulated by the Bill.

Foreign banks may see the financial conglomerate provisions of the Bill as intrusive and burdensome – and in many respects they would be correct. However, SARB, and the Prudential Authority specifically, have been tasked with ensuring financial stability and mitigating any systemic event that may arise in South Africa. The Bill defines a “systemic event” as “an event or circumstance, including one that occurs or arises outside the Republic, that may reasonably be expected to have a substantial adverse effect on the financial system or on economic activity in the Republic, including an event or circumstance that leads to a loss of confidence that operators of, or participants in, payment systems, settlement systems or financial markets, or financial institutions, are able to continue to provide financial products or financial services” (our emphasis).

The definition of a systemic event recognises that financial institutions such as banks operate within the context of a globalised world, and that what happens to the financial system in one jurisdiction may have an adverse effect in another jurisdiction.

Financial instability and systemic events may occur in South Africa as a result of the actions of a foreign bank, by virtue of that foreign bank having an interest in South Africa. For this reason, the Prudential Authority has been empowered to look into the financial exposure of foreign banks, question the governance and management standards used by foreign banks and their holding companies, and even request information about companies within the group of companies to which the foreign bank belongs that are not financial institutions.

In our view, this is not unusual. The Bill gives effect to the Government’s decision to shift to a Twin Peaks model of financial sector regulation in South Africa. The shift to Twin Peaks comes about as a result of the 2008 global financial meltdown, and implementation of this model of regulation that will see the strengthening of South Africa’s approach to consumer protection and market conduct in financial services, and the creation of a more robust financial system.

The Bill is still being considered by Parliament’s Standing Committee on Finance (SCF). It remains to be seen whether the SCF will make any changes to the Bill, especially to the more stringent regulation of financial conglomerates, before it is sent to the National Assembly for approval, and finally to the President for assent.

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