FREE TO READ | Collective Insight: Financial regulations: a balancing act

Fran Troskie

COLLECTIVE Special report

For inquiries contact Anne Cabot-Alletzhauser on cabota@gibs.co.za

Convener: Anne Cabot-Alletzhauser Practice director of the Gordon Institute of Business Responsible Finance Initiative Editorial advisory commi ee: Kelly de Kock Chief operating officer at Old Mutual Trust Company Prof Evan Gilbert Associate professor at Stellenbosch University and strategist at Momentum Investments Amanda Khoza Vice-president and board member of the Institute of Retirement Funds SA. Caretha Laubscher Manager: Consumer Education Framework, Financial Sector Conduct Authority Lelane Bezuidenhout CEO Financial Planning Institute of Southern Africa Nici McDonald HOD: Certification and Standards, Financial Planning Institute of Southern Africa Darius van der Walt Member of the ASSA investment commi ee, head of product development at M&G Investments Southern Africa Nerina Visser, CFA ETF strategist and financial adviser etfSA Langa Madonko Principal for investor relations and capital raising at Summit Africa Fran Troskie Manager of research and investment advisory at PPS Investments

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Collective Insight is a collaborative initiative published quarterly by the Financial Mail.

The articles included here were selected by an independent Advisory Commi ee to reflect some of the best insights from investment professionals, practitioners, and academics in relation to selected financial challenges.

Collective Insight enjoys the support of the Gordon Institute of Business Science’s Responsible Finance Initiative, the CFA Society of South Africa, the Financial Planning Institute, ABSIP and the Actuarial Society of South Africa.

Our vision was to create a journal that SA’s broader investment community and its stakeholders could collectively “own”, carrying content totally independent of commercial interests.

Who is the survey about?

CREATING FINANCIAL REGULATIONS: A BALANCING ACT We need to feel that regulatory changes are ultimately a force for good, not a minefield we need to navigate e might be forgiven for thinking that financial regulation is a process that plods along, picking up an extra clause here, a revised definition there, inviting a couple of new friends (extra rules) to join it on its meandering route to becoming a simple, comprehensible, cohesive framework.

Forgiven, perhaps, but ultimately mistaken, and some mistakes are costly.

Financial regulations evolve as the wants and needs of industry participants change, and sometimes these participants have different requirements and different visions of what regulations should and can do.

Financial regulations can create a stable, sustainable and transparent environment, in which individuals are held accountable for their actions and participants feel protected. As financial sector participants — asset managers, financial planners, large institutional investors, brokers, retirees and the average person who is saving for a new car — we need to understand how the regulations affect us.

We need to feel that regulatory changes are ultimately a force for good, not a minefield that we need to navigate.

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Particularly in South Africa, we need to see a regulatory framework which facilitates more inclusive and equitable economic growth.

Financial sector regulation in South Africa is not a process which can simply plod along: our country is still a toddler in terms of democratic rule, our society is highly divided in terms of the haves and the have-nots, financial education is a luxury that few of us have access to.

South Africa has seen several relatively rapid changes in financial sector regulation. We’ve just witnessed the publication of the Revenue Laws Amendment Bill 39 of 2023 (the “two-pot” legislation).

It still needs to be adopted by both chambers of parliament, before being signed into law by the president.

Simultaneously, the retirement fund industry is waiting with bated breath for the draft amendments to the Pension Funds Act to be published and signed into law. This comes amid competing demands from politicians, labour unions and members.

We’ve moved from a world where retirement funds were mutual societies, run by members for the benefit of members. We’ve moved from a world where trustees of pension funds were ultimately incentivised to make the best decision for members, because they were themselves members of the funds under their care.

We’ve moved from a world where banks were considered safe as houses — Silicon Valley Bank, or even African Bank

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Who is the survey about? (before the turnaround) disproved this assumption. We’ve moved from a world where we could pick between (more or less) a “big five” of asset managers to take care of our investments. We’ve moved from a world where crypto seemed like a misspelt reference to a crossword and alternative was a genre of music.

Have financial regulations moved with us? Are they keeping pace with the wants and needs of financial sector participants and society as a whole? Are we moving in the right direction?

These are the questions we posed to our contributors for this quarter’s edition of Collective Insight. To be fair, we don’t expect an answer. If we were omni-

scient, we’d all live from our lottery winnings.

But this thought-provoking collection of articles highlights the diverse ways in which financial sector regulation can and does affect us. It provides several views regarding areas which the regulator may have overlooked or may still be grappling with.

It is not a criticism of the country’s financial regulators; it is a call for greater collaboration and enhanced transparency in creating an effective, equitable and stable regulatory framework. x Troskie is manager research analyst at PPS Investments

THE EFFICACY OF FINANCIAL REGULATIONS: ARE WE UP TO DATE OR IN THE DARK?

Lizl Budhram

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We usually know what the costs of compliance are, but managing the data to judge the benefits is a challenge he world of finance is moving faster than ever, and it’s crucial that regulations remain relevant in the face of rapid change. The challenge lies in the scarcity of comprehensive data, leaving us to wonder if our current regulations effectively protect consumers and simultaneously encourage ethical, fair and transparent behaviour from industry stakeholders.

In the multifaceted world of finance, there is no “one size fits all” answer to this question. In fact, it probably raises even more questions. Without the necessary objectively analysed data, we’ll have to subjectively weigh the intent and impact of specific individual regulations to assess their efficacy.

An essential gauge of regulatory efficacy is weighing the cost of compliance against its benefits.

Most financial service providers spend quite a bit of their budget to adhere to

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regulations, but the recent BHI Trust case illustrates that consumers can still end up with battle scars despite the trust remaining outside regulatory oversight.

When such events occur, we need to ask whether regulations adequately protect consumers. We don’t know whether cases like BHI are common, mainly because we don’t know whether we have the necessary data or how to access and use it.

These types of events also emphasise the importance of continuous reassessment, of addressing our shortcomings, of building on our strengths.

As an industry, we need to ask the hard questions: could such a failure have been prevented, and if so, how? Even tighter regulations, more oversight, more stringent corporate governance? How do we hold the responsible and disreputable parties accountable?

The bottom line is that regulations

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should give consumers the security that they are dealing with competent and reputable advisers so that this type of loss doesn’t occur. For that, we need data.

We don’t, as an industry, necessarily get to grips with the data that is available, and we don’t necessarily see the benefits. We are, however, typically able to quantify the costs of compliance. A comprehensive cost-benefit analysis undertaken by all relevant industry stakeholders is essential to determine if the current form of the Financial Advisory & Intermediary Services Act justifies the considerable expense and effort.

In the meantime, regulations such the two-pot retirement system and the Conduct of Financial Institutions Bill are created for the benefit of the consumer. Yet they will have enormous cost implications for the industry.

Companies across the spectrum will have teams of people spending significant amounts of time and effort refining and implementing product changes and internal systems, not to mention costs such as education, marketing and training, to name a few.

While the changes in regulations are designed to benefit the consumer, the costs incurred by the industry may eventually be pushed onto the consumer.

A collaborative cost-benefit analysis in which all relevant industry stakeholders participate would bolster the understanding of the interplay between the costs and the benefits (in the short and long term) of the proposed legislation.

So, are our regulatory practices working as they should?

Right now, we fall short of having the necessary insights to determine whether our legislation is propelling us forward or holding us back. This is not necessarily due to a lack of data, or due to any institutional failure in making data available.

Perhaps we simply underestimate the scope and scale of the undertaking: collecting, collating, clarifying and effectively distributing data takes time and resources.

And data has limited use if it is not converted into information which can be readily and easily communicated.

From government to academia, corporates and regulators, now is the time for self-assessment and collaboration. By doing the research and sharing the outcomes, new solutions and informative conclusions might come to light that will help us find the best way forward, for our industry and for every South African who relies on us. x Budhram is head of advice at Old Mutual Personal Finance

Langa Madonko

Rob Rusconi

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SCRUTINISING LEGISLATION Detailed assessments of the costs and benefits of any regulatory intervention are crucial omplexity seems to be ubiquitous.

Markets thrive on it. Customers are confused by it. And the legislative process appears unable to avoid it.

Surely lawmaking would be enhanced by a process of transparent evaluation of the costs and benefits of each legislative intervention.

Regulatory impact assessment (RIA) is a mandatory part of all lawmaking in this country. We should insist on its transparent and effective implementation.

Most of the rules that regulators put in place are consistent with sound business practice, but demonstrating compliance with these rules can be expensive. Since the consumer ultimately bears this cost, regulators should take care to ensure that regulatory requirements represent appropriate expenditure for the goals that they seek to achieve.

The process of establishing the costs and benefits of legislative change is known as RIA. It asks whether any initiative planned by government is worth the cost.

RIA is not only helpful ahead of reforms or new legislation, it’s also a useful framework to determine whether benefits did in fact exceed the corresponding cost. Australia, for example, requires regular reviews of its laws and those where the costs outweighed the benefits are axed or phased out.

The discipline of RIA brings with it many benefits. It improves the transparency of decision-making, in the process improving governance and ensuring accountability. It guides policymakers’ and regulators’ decision-making, making positive outcomes from the process more likely, and it more efficiently allocates scarce regulatory resources.

RIAs provide objective measures of the expected welfare gains, giving a natural benchmark for assessing the success of the initiative later. It strengthens the missions of the regulatory agencies, and it enhances consistency of methodology across agencies, reducing the risk of prolific yet pointless regulations.

However, RIAs aren’t easy. The cost

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side of the equation is difficult enough.

How do you assess expenditure on compliance? Surely that should already be accounted for, given the best-practice principles financial services providers need to adhere to? Taking social impacts into account is important, as recognised by South African policymakers in RIA, but it isn’t easy.

Playing devil’s advocate: surely a detailed analysis of the costs and benefits of any regulatory intervention will have costs which far outweigh the corresponding benefits? Perhaps, but the reality we face is that we can only assess whether regulations are working if we use a transparent, consistent and repeatable process such as RIA. For example, the two-pot system will allow limited access to accrued retirement savings in return for confirmed preservation of the remainder. We have seen very few formal RIAs, or at least none that ise readily available.

Several elements of Any new l e g i s l at i o n such an assessment would be helpful. We must aimed at i m p rov i n g consider the social and economic benefit of immep e o p l e’s diate access to some of the l i ve s should be accumulated savings, along with the correspondevidence based and ing long-term gains or o b j e c t i ve losses in terms of retirement income.

The extent to which the approach would affect the current tendency for employees to resign to access retirement savings must be considered. The implementation costs are obviously high and will be borne by fund members. If they have been quantified, this has not been disclosed in policy documents.

This is not an easy process. An effort should nevertheless be made to identify and disclose the costs and benefits of these proposals, improving transparency in the process. Otherwise, this important piece of legislation will see its foundation easily eroded.

There are whispers that the two-pot pension system has been rushed through with an election in mind. Any new legislation aimed at improving people’s lives should be evidence-based and objective, improving the accountability of the lawmaker in the process.

The South African framework rightly requires RIA as part of all legislative development. We don’t see that it is being applied. x Rusconi is a pension and insurance policy researcher and consultant at Tres Consulting

STOP AND LOOK AT THE BIG PICTURE Regulators need to formulate policies governing finance and investment that take into account the complex diversity of our country

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outh Africa’s national anthem starts as a prayer for hope and mutual prosperity, which in many ways reflects why we become so passionate about financial services facilitating the changes we want to see. The multilingual nature of the verses can be viewed as encapsulating not only our diversity, but also the needed diversity in financial products and solutions to suit most of the country’s citizens.

It is also the complex diversity for which regulators need to formulate policies governing finance and investment.

First, let me say that we are all trying to achieve the same objectives as an industry and as regulators.

However, regulators arguably have a few more objectives they need to achieve, such as ensuring the fair treatment of customers who select to invest, save or transact; ensuring that the product set and the attendant regulations minimise the potential for harm (bear in mind, I did not say loss); and creating a framework to ensure that investors are sufficiently equipped to make appropriate choices.

That may be what is at the core, but we are not oblivious to the fact that there are other priorities, including stimulating economic growth, moving towards a more inclusive financial system and ensuring that the financial infrastructure and landscape allow us to compete and participate on the global stage.

Sometimes, the legislation seems counterintuitive or counterproductive or simply

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Lerato Lamola & Analisa Ndebele

incomprehensible. As an example, I’ll focus on the recent change to regulation 28 of the Pension Funds Act. The change allows retirement funds to allocate up to 15% of assets to private equity. It was meant to allow greater participation from investors to fund much-needed infrastructure investments, which in turn would bolster economic growth.

However, this legislation was perhaps written in isolation from the increased (45%) offshore allowance and the propagation of the two-pot system.

In brief, regulation 28 aims to guide prudent asset allocation and ensure that appropriate risk-and-return assessments are undertaken when allocations are made.

In response to a dwindling pool of listed companies on the local stock market and a challenging domestic investment universe, there have been several consultants who have advocated that their clients increase their offshore exposure.

This means the pool of capital available for potential allocation to private equity funds, which can act as an anchor for infrastructure investment, becomes a proportion of the remaining domestic allocation of 55%.

Let’s acknowledge that the capital in this domestic pool is made up partly of more risk-averse investors, who require stable returns and who focus on capital preservation. Let’s also factor in that the two-pot system requires a degree of liquidity in the savings pot. Private equity, while having the potential to deliver solid returns, is also considered riskier and is typically illiquid.

Ultimately, we are likely to see a situation in which private equity never reaches the 15% regulatory cap, particularly for smaller pension funds which cannot meet a typical private equity fund’s minimum capital commitment.

Subsequently, the regulations have unintended consequences, which are at times difficult to communicate to regulators. We acknowledge that the regulators are always willing to engage, but sometimes there are attendant legal fees. Poring over legislation, poking holes in clauses and drafting submissions don’t come free.

It would be ideal to find avenues for greater communication and a collaborative consolidation of the legislative process, allowing participation from multiple roleplayers, and allowing for a spectrum of views. x Madonko is the co-founder and principal of Summit Africa

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REGULATING THE BOOMING CRYPTO MARKET illegal financing concerns.

Consistent financial sector regulation creates certainty and enables effective and efficient regulation of the South African crypto industry he global market for crypto assets has mushroomed.

South African regulators have arguably been on the front foot, incorporating crypto assets into legislation since 2019, when the crypto assets regulatory working group published its first consultation paper. It outlined prominent policy proposals and regulatory approaches to industry stakeholders.

At the end of 2022, South Africa took bold steps to include crypto assets within the financial sector regulatory regime.

However, we still seem to lack a common and comprehensible definition regarding what a crypto asset is within the South African context.

The Financial Action Task Force, an independent international intergovernmental body established to protect the global financial system against money laundering and terrorist financing, specifically recommended the regulation of crypto asset service providers for anti-money-laundering and counterterrorist financing purposes.

It is argued that crypto assets pose money-laundering and terrorist financing risks because they permit anonymous transactions. The inclusion of crypto asset service providers in the Financial Intelligence Centre Act seeks to address these

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From a Financial Advisory & Intermediary Services Act perspective, crypto is often misunderstood by vulnerable consumers who may view crypto as a way of getting rich quick.

Based on the two pieces of legislation that the regulators have chosen to focus on as an interim step, from a South African perspective, the aim is to protect consumers and prevent money laundering and terrorist financing, as well as combat the proliferation of funds. This is laudable, but it remains a stop-gap measure.

The hope is that the Conduct of Financial Institutions (CoFI) Bill, which aims to strengthen the regulation of the way in which the financial services industry treats its customers, will bring cohesive regulation of crypto assets.

At this stage, however, it is unclear when the CoFI Bill will be finalised and promulgated.

The CoFI regime will require a deeper understanding of the role-players in the crypto ecosystem and clarity on who bears liability if things go wrong. We need the bill to create this comprehensive regulatory regime for crypto assets, and we need an inclusive, collaborative approach.

Consistent financial sector regulation creates certainty and enables effective and efficient regulation of the South African crypto industry. It facilitates consumer education and protection. It allows South African market participants (including crypto asset managers) to remain relevant in this fast-paced, increasingly globalised financial sphere. x Ndebele is an associate and Lamola an associate director for financial regulation at Webber Wentzel

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Fran Troskie

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PROTECTING CONSUMERS FROM CONFUSION

CA, CPA, FSR, CoFI … No, believe it or not, I am not jotting down gobbledegook or odd abbreviations for items on my shopping list. These are acronyms of South African laws that aim to enhance consumer protection.

The NCA (National Credit Act 34 of 2005), the CPA (Consumer Protection Act 68 of 2008), the FSR (Financial Sector Regulation Act 9 of 2017) and the next iteration of the CoFI Bill (Conduct of Financial Institutions Bill) have laudable aims and lofty ambitions. One of these aims is to support the National Development Plan in its goal of achieving financial inclusion of at least 90% by 2030.

One goal of the CPA is to promote consumers’ financial education. In South Africa, a vast abyss separates relatively affluent and (mostly) financially literate consumers from the less wealthy and potentially less financially savvy majority.

The act requires, among other things, that service providers, including financial services providers, communicate information in plain and simple language.

Nowadays, regardless of what our bank statements look like, we all suffer from a paucity of time. This can be exploited by the organisations we deal with, or it can be harnessed for good.

What does exploitation look and feel like? (Aside, that is, from requiring the time to find and read the terms and conditions.)

It is the feeling of being bombarded with so much information that my head is spinning. It is the feeling of being put through to the nth different operator when I am trying to find out how to cancel or amend my insurance policy. It is the feeling of finally giving up, of taking the path of least resistance, and the sinking feeling of seeing those monthly debit orders go off my bank account. And bear in mind that this assumes that I am in the fortunate position of having airtime to call the service provider and that I have anything worth insuring.

On the flip side, what does it mean when our paucity of time is harnessed for good? It means that the process of select-

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By law, service providers have to communicate with their users in plain and simple language

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ing a financial product or service is streamlined and simplified. This requires clear communication and easily accessible information — essential tools when it comes to financial education. Jargon is not.

Nor are acronyms and abbreviations.

The CPA and the NCA, to some extent, address the need for financial education.

Finance professionals sometimes struggle to understand the standard of education that needs to be provided to financial service consumers. To give them the benefit of the doubt, albeit begrudgingly, this might be why some financial service providers feel that referring me to the T&Cs is sufficient. At the same time, most consumers are uncertain about the level of financial education or type of information they are entitled to receive. Nor do they necessarily have the means, time or financial appetite to find out (especially when the T&Cs are Tiny&Complex).

The ambiguity about what constitutes an adequate standard of financial education ultimately means that the NCA and the CPA fail to achieve their aims.

Even more disconcertingly, inadequate financial education has a domino effect: a sufficient level of it is a prerequisite for financially empowered consumers to participate effectively in the financial sector and in economic activities. Financial education goes hand in hand with financial inclusion; it is one of the tools that can be used to address the yawning chasm between the haves and the have-nots in our highly unequal society.

So, where to from here? Additional

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regulations will not address the problem.

Inadequately enforced rules and regulations merely result in regulatory fatigue and disillusionment.

Perhaps we should adjust our expectations of our authorities. Much as the private sector has come to the party in the provision of electricity, perhaps the financial services sector should come to the party when it comes to financial education.

Perhaps the solutions to achieving greater financial inclusion aren’t to be found in some lengthy policy document or its prolific footnotes.

What can we, as participants in the financial sector, do?

We can and must provide products and services that are appropriate and accessible, backed by common sense principles and extensive research.

Blue sky thinking, perhaps, but we can facilitate or sponsor workshops and financial literacy programmes in underserved areas.

South Africa’s financial authorities are neither omnipresent nor omniscient, and the rules and regulations can have unintended consequences (yes, it’s my gripe with the T&Cs again).

Self-regulation is often far more effective than any toothless state-sanctioned threat. Reputation is immeasurably valuable in our industry. We must therefore hold ourselves, individually and collectively, accountable. x Troskie is manager research analyst at PPS Investments