Chapter 1: Regulation and the role of various regulators

Question 1

In South Africa, economic policy is based on the philosophy that the market ensures efficiency at all times. True or false?

Answer 1

False. Regulation is used to combat the negative effects of market activity.

Question 2

A regulator should do a cost-benefit analysis of proposed regulations. True or false?

Answer 2

True, as unnecessary or burdensome regulation may adversely affect the economy.

Question 3

Regulation may have adverse consequences in the economy. True or false?

Answer 3

True

Question 4

Regulation consists of which three elements?

Answer 4

Establishing rules relating to a particular industry for example enactment of legislation; monitoring (determining whether the rules have been complied with) and enforcement (ensuring that the rules are followed).

Question 5

What are the objectives of regulation?

Answer 5

The objectives of regulation are to
 protect consumers and investors;
 ensure the solvency and financial soundness of the country’s financial institutions;
 promote fairness, efficiency and transparency in the securities markets; and
 promote a stable financial system by monitoring, mitigating and managing systemic risk.

Regulations should facilitate capital formation and economic growth.

Question 6

Discuss how ethical rules of behaviour have become matters of law in South Africa.

Answer 6

The FSB gave legal effect to codes of conduct by issuing them as subordinate legislation e.g. in terms of the Financial Advisory and Intermediary Services Act, 2002 (FAIS) several codes of conduct have been issued whose main aim is the protection of consumers. There is an all-encompassing General Code of Conduct, with special codes for example for specific sections of the industry. The Financial Markets Act also provides for various codes of conduct to be issued for the various market participants including authorized users, participants or clearing members of independent clearing houses.

Question 7

Explain how the regulatory landscape is split horizontally in South Africa.

Answer 7

In terms of the Financial Markets Act (FMA), a licensed exchange, a clearing house and a central securities depository (CSD), operate as SROs, regulating their own activities and those of authorized users and participants (members of central securities depositories) and clearing members of independent clearing houses in terms of the provisions of the FMA.

Question 8

The FAIS Act mainly makes use of prudential regulatory measures in regulating and supervising the activities of financial advisers and intermediaries. True or false?

Answer 8

False. The FSB concentrates on rules of market conduct for the protection of consumers since prudential regulation of the individuals and smaller companies acting as advisers and intermediaries is not deemed necessary. However, the FSB is investigating the possible introduction of prudential requirements in certain cases and is also now requiring liquid assets of varying amounts depending on the category of FSP. In addition FSPs are required to have guarantees and professional indemnity and fidelity guarantee insurance in place depending on the category of FSP and whether an FSP receives or holds clients’ cash or financial products. The functions of an exchange in terms of the FMA are to establish, maintain and provide an infrastructure to bring together buyers and sellers of securities and match their orders.

Question 9

What are the functions of an exchange in its capacity as an exchange and its capacity as an SRO?

Answer 9

An exchange provides the infrastructure for the trading of securities listed on the exchange i.e. bringing together buyers and sellers of those securities in respect of which a licence has been obtained and matching those orders to buy or sell. The exchange must also provide for the clearing and settlement of transactions.
As an SRO, an exchange must issue and enforce rules, directives and listing requirements, ensure compliance with the rules by authorised users and listing requirements by the issuers of securities and suspend rules and listing requirements under certain circumstances.

Question 10

What are the functions of the Directorate of Market Abuse?

Answer 10

The Directorate of Market Abuse is responsible for investigating insider trading in addition to manipulative, improper, false or deceptive practices of trading as well as false, misleading or deceptive statements, promises and forecasts and taking civil action if necessary.

Question 11

Discuss the powers of an inspector in terms of the Inspection of Financial Institutions Act, 1998.

Answer 11

An inspector may with regard to an institution
 administer an oath or affirmation or examine any person who is or was a director, servant, employee, partner, member or shareholder of a financial institution;
 without prior notice enter and search the premises of the institution and require the production of documents relating to the institution;
 open any strong room, safe or other container in which he or she suspects any documents are kept;
 examine and make extracts from and copies of any documents, or against a receipt, remove the above temporarily from the premises for that purpose;
 against the issue of a receipt, seize any document which may afford evidence of an irregularity; and
 retain such seized documents for as long as they may be required for any criminal or other proceedings.

Question 12

What are the functions of an actuary in a retirement fund?

Answer 12

Retirement funds use actuaries to do actuarial valuations and to ensure that assets and liabilities are matched.

Question 13

Discuss the investor protection measures contained in the Pension Fund legislation.

Answer 13

Specific consumer (member) protection measures include:
 Member representatives on the Boards of Trustees;
 Benefit statements;
 Internal complaints resolution and access to the Pension Funds Adjudicator (ombudsman);
 Allowing members to share in pension fund surpluses; and
 Monitoring and enforcing the prudential limits in terms of regulation 28.

Question 14

Discuss the measures used to regulate collective investment schemes.

Answer 14

The following measures are used:
 managers of CIS’s must be registered in terms of the Act;
 managers of CISs must comply with the Fit and Proper Requirements in terms of the Board Notice issued in terms of the Act;
 managers of CIS’s must comply with capital requirements and provide seed capital for each portfolio they administer;
 portfolios must comply with prudential investment guidelines;
 the prior approval of the Registrar is required in respect of each new portfolio;
 managers must comply with quarterly reporting requirements;
 investors must receive annual reports containing prescribed information.

Question 15

Who regulates money-laundering activities in South Africa?

Answer 15

The regulatory authority responsible for the implementation of FICA is the Financial Intelligence Centre.

Question 16

Who is responsible for the regulation and supervision of ombudsman schemes?

Answer 16

An independent council reporting to the Minister.

Question 17

The advantages of an SRO.

Answer 17

• It offers extensive expertise regarding market operations and may be able to respond more quickly than other bodies to changing market conditions.

Question 18

What is the enforcement options that regulators use?

Answer 18

 referral for criminal prosecution;
 withdrawal of authorisation or licence to do business and resultant winding down of a business;
 curatorship to take control of the business of the regulated firm;
 business rescue proceedings;
 penalties; and
 civil actions and orders to compensate prejudiced consumers.

Question 19

What is the requirements that general regulations should comply with?

Answer 19

 barriers to entry and exit from markets and products should be kept to a minimum to ensure access for the widest possible range of participants
 regulatory measures should not be implemented if their impact and consequently the cost to the economy have not been evaluated. The benefits of regulation should always exceed the cost of regulation
 restrictions and requirements for participants offering the same product should be equal. For example there should be no difference between the regulatory requirements for banks and insurance companies if both wish to offer investment management services
 a regular review of the perimeter or scope of regulation should take place i.e. what should be regulated and what should not.

Question 20

What is the advantage for suppliers of financial services when consumers are protected?

Answer 20

The consumers are more confident in making use of the services.

Question 21

Why was the financial stability board established?

Answer 21

The Financial Stability Board has been established to coordinate internationally initiatives to develop and promote effective regulatory, supervisory and other financial sector policies.

Question 22

What is corporate governance?

Answer 22

Corporate governance refers to those principles and procedures underlying the way in which companies and other organisations should be directed and controlled.

Question 23

What is the functions of the FSB in terms of the Financial Services Board Act, 1990?

Answer 23

 supervise compliance with laws regulating financial institutions and the provision of financial services;
 advise the Minister on matters concerning financial institutions and financial services;
 promote consumer education programmes and initiatives by financial institutions and bodies representing the financial services industry.

Question 24

The Registrar of Financial Services Providers authorizes and supervises various categories of FSPs:

Answer 24

 Category I: Financial advisers and intermediaries who may not use discretion in the rendering of financial services.
 Category II: Intermediary services in terms of a mandate granting to the FSP discretion regarding the choice of financial products.
 Category IIA: Hedge fund managers.
 Category III: Investment administrators specializing mainly in bulking collective investments on behalf of clients (linked investment services providers).
 Category IV: Assistance business administrators (funeral brokers).

Question 25

The FAIS Act lays down a comprehensive regulatory framework applying to financial services providers (FSPs). Some aspects covered in the Act and subordinate legislation is:

Answer 25

 only fit and proper persons only will be licensed to conduct the business;
 an FSP, key individual and representative of such FSP must comply with prescribed competency requirements that include qualifications and experience;
 an FSP must maintain a compliance function that must be exercised with diligence, care and competency;
 an FSP or its representative must avoid and where this is not possible, mitigate any conflict of interest between an FSP or representative and the client;
 an FSP, other than a representative, must adopt, maintain and implement a conflict of interest management policy that complies with the provisions of the Act.
 an FSP must be solvent and, in the case of FSPs holding assets or receiving money, must in addition have sufficient current assets to meet current liabilities and maintain a prescribed number of liquid assets, depending on the category of FSP. In the case of Category IIA and III FSPs, additional prudential requirements will apply;
 an FSP must hold guarantees and fidelity guarantee insurance and professional indemnity insurance depending on the category of FSP and whether it receives or holds clients’ cash or financial products;
 an FSP must comply with the operational requirements such as having a fixed address and telephone, a bank account, storage and filing facilities and appropriate anti money laundering control systems;
 an FSP must have proper accounting records and be audited annually;
 an FSP must, in addition, submit a report by the auditor certifying the amount of cash and market value of assets held on behalf of clients and whether such cash and assets are held separately from its own cash and assets;
 an FSP must comply with the General Code of Conduct in addition to the special Code of Conduct applicable to the industry concerned. The General Code lays down requirements with regard to disclosure to clients, record-keeping, statements to clients, accounting, auditing, conflicts of interest, procedures on furnishing advice and the suitability thereof, records of advice, custody of funds and assets, risk management, internal controls, advertising, the control or prohibition of incentives paid by or accepted by an FSP and complaint resolution;
 provision is made for the establishment of the Ombud for Financial Services Providers to hear and adjudicate complaints that cannot be resolved by the internal complaints resolution mechanisms.

Question 26

The three departments of the Investment institution division:

Answer 26

 Capital markets
 Market Abuse
 Collective investment schemes

Question 27

What are the functions of the capital market department of the FSB?

Answer 27

It supervises the South African licensed exchange, central securities depository and clearing houses in terms of the Financial Markets Act, 2012. The department strives to ensure sound, efficient and fair capital markets and related services for trading, clearing and settlement of securities, including appropriate mechanisms for investor protection.

Question 28

Collective Investment Schemes (CIS) are regulated in the following manner:

Answer 28

 Managers of CISs must be registered in terms of the Act.
 Managers of CISs must comply with the fit and proper requirements.
 Managers of CISs must comply with capital requirements and provide seed capital for each portfolio they administer (except in respect of exchange traded portfolios listed on an exchange).
 Portfolios must comply with prudential investment guidelines.
 The prior approval of the Registrar is required for each new portfolio.
 Managers must comply with quarterly reporting requirements.
 Investors must receive annual reports containing prescribed information.

Question 29

Credit rating agencies are regulated in the following ways:

Answer 29

 Registration of credit rating agencies.
 Prohibiting unregistered entities from issuing credit ratings or providing credit rating services.
 Fit and proper requirements with regard to the company, directors and employees including personal character qualities of honesty and integrity, competence, operational ability and financial soundness.
 Circumscribing duties of a credit rating agency including aspects such as the duty to avoid conflicts of interests and to ensure that the independence of credit ratings is not impaired by business interests; proper administrative procedures, accounting and internal control measures; effective risk management mechanisms and ensuring that management and staff have adequate knowledge and experience.
 Requirements with regard to the methodologies, models and key rating assumptions.
 Requirements with regard to the publication of a rating or a decision to discontinue a rating, including information on the attributes and limitations of a rating and an explanation of the key elements underlying a credit rating.
 Adoption of a code of conduct, adhering to the principles of the international code of conduct.
 Compulsory disclosure to investors and the public regarding the practices, procedures, processes, methodologies, models and key rating assumptions used in credit rating services, the code of conduct, compensation arrangements and the policy on publishing credit ratings.
 A requirement that an independent compliance unit be established at a credit rating agency.
 Requirements with regard to the preparation and auditing of financial statements.
 Delictual liability for damage, loss or costs sustained as a result of the credit rating issued or credit rating service performed over and above contractual liability.
 Inspections and onsite visits to determine compliance with the Act.
 International cooperation with other regulatory authorities.

Question 30

What is the Solvency II Directive?

Answer 30

The Solvency II Directive of the European Parliament and Council (Solvency II) is an international benchmark for the regulation of insurance companies which the FSB as adopted through its risk based solvency regime for South Africa known as the Solvency Assessment and Management Regime, expected to be in place by 2016. Solvency II stresses a three pillar approach namely firstly quantitative requirements, risk management and corporate governance, and reporting and disclosure requirements.

Question 31

The FSB supervises retirement funds by

Answer 31

 registering funds and approving their rules to ensure compliance with the guidelines prescribed in the Act, including minimum withdrawal benefits;
 analysing the annual audited financial statements and ensuring that investments comply with prudential investment guidelines;
 analysing actuarial reports to ensure that funds will be able to meet their liabilities;
 enforcing payment of contributions by employers to employer funded funds; and
 monitoring and enforcing the prudential limits in terms of regulation 28 issued under section 36 of the Pension Funds Act of 1956, published in 1962, which limits the amount and the extent to which a pension fund may invest in particular assets or in particular kind or categories of assets.

Question 32

The FSB supervises friendly societies by

Answer 32

 registering funds and approving their rules to ensure compliance with the guidelines prescribed in the Act; and
 analysing the annual audited financial statements and ensuring that investments comply with prudential investment guidelines.

Question 33

An inspector may, with regard to an institution:

Answer 33

 administer an oath or affirmation, or examine any person who is or was a director, servant, employee, partner, member or shareholder of a financial institution;
 without prior notice enter and search the premises of the institution and require the production of documents relating to the institution;
 open any strong room, safe or other container in which he or she suspects any documents are kept;
 examine and make extracts from and copies of any documents, or against a receipt, remove the above temporarily from the premises for that purpose;
 against the issue of a receipt, seize any document which may afford evidence of an irregularity;
 retain such seized documents for as long as they may be required for any criminal or other proceedings.

Question 34

What is the object of the Financial Intelligence Centre (FIC)?

Answer 34

The objective of the Financial Intelligence Centre (FIC) is to identify the proceeds of unlawful activities and to combat money laundering activities. It will provide timeous financial intelligence for use in the fight against crime, money laundering and terror financing.

Question 35

On what is the 3 principles based that the Financial Intelligence Act (FICA) 28 of 2001 provides for control measures to facilitate the detection and investigation of money laundering

Answer 35

 intermediaries in the financial system must know with whom they are doing business, the so-called “know your client” principle;
 the paper trail of transactions through the financial system must be preserved; and
 possible money laundering transactions must be reported.