Financial Advisory and Intermediary Services Bill: briefing on Cost-Benefit Analysis

Mr Morajele outlined the uses and limitations of cost-benefit analysis in the South African context. SA has two sectors; a first world, developed sector and a third world, undeveloped sector. Emerging brokers view FAIS as legislation about the first world.

The following is a brief summary of their methodology and key findings. Please refer to their presentation for the full findings.

Methodology
Genesis reviewed and adapted methodology employed by the Financial Services Authority of the United Kingdom. Interviews were conducted with brokers' associations, new companies established to assist with compliance with the Bill, ombudsmen, the banking industry and independent emerging brokers as well as health industry brokers.

They found the participatory nature of the Bill to be positive. Since 1997 there has been interaction with industry players on the Bill. The cost of the Bill to Black brokers is important. The FSB could perhaps look into doing research into that aspect.

They divided costs into two types; initial start up costs and annual recurring costs.

Their approach was to look at individual intermediaries; given that they interact with consumers. Four types of intermediaries were used and the cost to each differs substantially:
Independent brokers, who serve the developed market
Emerging brokers, who serve the emerging market [both these categories need to register as service providers]
Insurance brokers, who have a mandate from a service provider or work for a corporate brokerage firm.
Bank representatives, who advise clients on traditional deposits.

It was found that there is a digital divide between brokers in the developed and the developing sector. The cost of compliance with D\FAIS becomes lower with access to a computer and the internet, because certain soft-ware assists with compliance requirements. It is assumed that brokers in the developed sector have access to a computer and the internet.

On the basis of information given, they assessed the opportunity costs per hour spent on regulatory costs. For the independent broker it is R250 per hour, R50 per hour for the emerging broker and R150 per hour for banks and insurance representatives. This was estimated on a conservative basis and may even be an underestimation.

There were twelve cost issues in the Bill, they include general cost of compliance, record keeping of representatives and code of conduct.

Framework for costs
For compliance with the Bill. The requirements of integrity require no cost while financial soundness is a prerequisite to be in the industry. Competency requires training.
Compliance costs can be met in many ways.
The cost of the ombud will be met by the industry. Compliance is at a greater cost for the emerging broker, who does not have the software to assist with easier compliance. Independent brokers initially have a low cost of complying with disclosure requirements or record keeping because they will use the compliance services offered by other companies. Either Sanlam, Mutual or other companies which have sprung up for this purpose. Corporates, however, will have to put in the systems for compliance right away and this means greater cost of compliance per representative.

They worked on an assumption that auditing would only be required by intermediaries who take in client's money. Investments managers who were previously regulated by the FSB have always had an audit. Brokers in the short-term insurance industry hand in premiums to insurance companies. But they hold these premiums for 45 days as a float and the interest forms part of their income; they therefore require an audit as well.

In terms of the code of conduct and disclosure the cost for representatives is less because of the scale economy of working for a large company but costs are higher for independent and emerging brokers. There are annual costs per individual for the intermediaries, The total costs to the independent broker of complying With FAIS totals around R14, 414. These are not insignificant annual costs. The cost for the emerging broker, for instance, would be almost equal to a month's salary.

Who will bear the cost of FAIS? Would it be the broker, the intermediary, product supplier or ultimately the customer? From the industry they understand that some costs will be born by the product supplier and to a small extent, the broker. A cynical view is that the customer will ultimately bear the costs. Because the initial cost will be shifted to the consumer the ultimate cost to the broker will be less.

How big is the cost relative to the marker, which has large flows on an annual basis? The premium flow, for instance, was around R67 billion and group schemes around R43 billion. Genesis estimated that the recurring costs (of the PPR and FAIS), as a proportion of total premiums is less than a quarter of a percentage. While for intermediaries it constitutes a greater part of their income as it weighs more on the emerging market.

Estimated Benefits: Insurance
One of the benefits of FAIS for the insurance industry is that it will reduce lapses, which is a real loss to consumers. Perhaps not all the losses can be stopped by FAIS. Lapsing may be due to cash-flow problems or because of mis-selling. The remediable loss in terms of reducing lapses through FAIS will be R550 million per year in an ideal situation. Even if FAIS is not yet fully complied with around R275 million can be saved for consumers.

Benefits and costs that cannot be readily quantified
The Bill could result in greater professionalisation of the industry, and a reduction in Masterbond-type financial disasters. Mr Malherbe cautioned that such disasters may never be completely avoided as the element of greed will not be eliminated.
If the Bill were too onerous it would be difficult to quantify the cost but it could result in lower levels of taking up investment products, given low household and national savings rates.

FAIS and empowerment. The environment of emerging brokers
Although Genesis found that the Bill is attractive what is its impact on the emerging market? The nature of the environment is such that there is growing competition with micro-lenders, which results in households spending more on debt servicing than savings and this impacts on brokers. The relation between direct marketers and the Bill also needs to be looked at as they represent competition to emerging brokers.

Understanding of proper advice is limited due to the low levels of education among customers. There have also been some shifts in demand for product types. There are more funeral policies being sold because the prevalence of HIV/AIDS.

Emerging brokers are challenged by poor infrastructure. Most black brokers have no infrastructure and computer equipment. Many emerging brokers are black-listed by the Credit Bureau themselves. The PPR and FAIS will impose new and perhaps unsustainable costs.

FAIS can affect saving; for better or for worse. Black brokers are part of a community where there is virtually no regulation of the credit industry. It is easier to access credit than insurance.

In conclusion, Genesis suggested a number of recommendations which could assist emerging brokers. Book-keeping requirements must be adjusted to be more in line with life practices while also protecting customers. There could be phasing and transitional assistance to emerging brokers. An audit could be required only for firms that handle client funds.

Discussion
Mr Ken Andrew (DP) welcomed the cost-benefit analysis of the Bill. He reminded Members that he introduced a Private Members Bill last year which would have required cost-benefit analyses, however the Bill was killed.

With respect to long-term and short-term insurance benefits, it could be assumed that the product which is better for the client will not necessarily have higher returns because they would be the lower risk products. Why then, would there necessarily be a better return of 0.5%? This is conservative when 1 in 200 clients would not be subject to mis-selling. The bigger clients will be better informed with larger amounts to invest. As a proportion of the money going in, is that conservative or correct?

Mr Malherbe responded that yes, sometimes low risk is more appropriate especially for the investor with a small sum of money. He concluded that this is a speculative field.

Mr Andrew reasoned that chances are good that competition would decrease, not increase, as the barriers to entry have been raised.

Mr Malherbe said that this depended on how appropriate advice will be understood. There has been an increase in the type of multi-services. Some officers offer a spectrum of products which provide a choice of the cheaper option. There is also a needs based cost analysis or affordability investigation. Sometimes the premium is not appropriate for the client although it may offer lower cover.

Mr Andrews asked whether there are figures available or has a study been done on what proportion of total investment outside the stock market has been lost?

Mr Malherbe said he did not know of such a study. Mr Anderson (FSB) said that this was difficult to estimate. But with FAIS coming to Parliament this year these unregulated schemes are brought in because they are now aware of them. The informal investment sector will be covered by FAIS and soon the Security Services Bill will be coming to Parliament.

Ms Joemat (ANC) asked for an explanation of the significant differences between the insurance and banking aggregate costs.

Mr Malherbe recalled that there has been talk about whether and what proportion of banks should be covered. The only product covered by FAIS is deposits for longer than twelve months. If banks were to become intermediaries, sell insurance and so forth in the long term the Bill will apply to them. Banks already have brokerages and these are effectively included in the insurance part of the Bill. They only costed the selling of deposits longer than twelve months. There are very few of these deposits and only around 8000 people need to be trained, which explains why the aggregate is low. The issue arises whether this aggregate is small or large in relation to the aggregate or size of the profits made in the selling of insurance. Two things make the banking sector different. An assessment is needed of the extent to which there have been consumer complaints in making deposits and there is no certainty of the actual benefits to regulating deposits. When a bank takes a deposit it is easy to assess its profit (deposit plus the interest revenue with a cost income ratio of 60%, with the costs taken off). Should a similar sum be done for long term insurance products? It may affect the decision of banks.

Mr Andrews (DP) said that in terms of banks and returns on investments; if their profits are going to go down will they offer the product at all and if they don't surely this will impact on the market? What is the solution?

Mr Wessels (FSB) responded that this point has not been raised by the banking council and does not seem to be of great concern to them.

Mr Nene (ANC) said that the benefits of the Bill outweigh the costs. Where does this leave emerging brokers? He was encouraged that merging brokers are keen on the professionalisation of the industry but how would the FSB see phasing in occurring? What is the view of the FSB on the issue of direct marketers?

Mr Wessels said that speaking as a draftsman, a mechanism has been created for phasing in. They are comfortable that this can be attended to in the framework of the Bill. This was also discussed with the Black Broker's Forum.

He said that the FSB are bent on creating and not taking away jobs. Direct marketing will also be covered by the Bill as it is not only through intermediaries.

Ms Hogan said that certain concrete measures were being suggested by Genesis. Have these been agreed to?

Dr van Zyl (FSB) said that they have been familiar with the report since late last year. The Bill is flexible and they have taken a note of recommendations.

Ms Hogan said that the Bill may cater for specific proposals such as the transitional assistance to emerging brokers. Who would take responsibility for that?

Dr Van Zyl said that people will know that they have a period of time within which to get ready for the operation of FAIS. The Registrar may grant exemption to allow companies to get ready to comply.

Mr Wessels said that the onus will be on industry. Assistance should come through industry bodies while advisory bodies representing the industry will take note of the assistance needed and will be in touch with the Registrar. Furthermore, a great deal is still happening before the introduction of the Bill. They will take up these issues through a consultative process.

Ms Hogan asked whether they were giving any undertaking to provide assistance.

Mr Wessels said that yes, they are committed to these recommendations regarding emerging brokers.

Ms Joemat (ANC) said that Black Brokers, who appeared before the Committee last year, were concerned about disclosure of profits, especially how it would be received by clients who often had a lack of education.

Mr Morojele said that other industries are not obliged to disclose profits on the sale of products but commission is a large part of those profits and they are therefore concerned how commission affects profits.

Mr Nene (ANC) raised the issue of the inclusion of micro-lenders. Savings are now in competition with lending. Has there been any change of heart by the FSB?

Mr Wessels said they have taken note of the comments and support for this principle. There have been discussions last year about the ultimate custodianship of the micro-lending industry. They do prefer more regulations and it seems as if this will land in the lap of the FSB.

Ms Hogan added that some oversight falls under the Usury Act and the Department of Trade and Industry. She understood that there was a move to consolidating legislation covering consumer protection. The Committee might consider including in their report that the FSB will consult with the National Treasury and the Department of Trade and Industry on this issue.

Clause by Clause consideration of FAIS
Mr Wessels continued to lead Members through the Bill where he had stopped the previous day.

Clause 44(5)
The Minister of Finance may exempt a financial services provider or representative from the Policyholder Protection Rules (PPR).

Dr Van Zyl explained that an earlier version of the Bill proposed that the PPR would be repealed to the extent that the PPR dealt with FAIS related matters. The LOA wished to know exactly which parts would be repealed [this is set out in the Resume relating to the PPR].

They drafted a notice exempting institutions from the PPR, except that issues not regulated by FAIS would remain under the PPR. The implication is that an institution would be subject to FAIS and, to the extent they overlap, they are exempt. If they do not fall under FAIS, they would fall fully under PPR.

Ms Hogan asked what the industry response to this was.

Dr van Wyk said that their concern was that the overlap must be addressed but the FSB are unsure of how they will accept the new proposed amendment. The LOA are aware of the draft and in principle have accepted it. But they have not yet circulated the draft notice of exemption.

Ms Hogan asked when it would be circulated. Dr Van Wyk said it would be within the next week.

Ms Hogan said it would have to be done swiftly as they want to get the Bill behind them. They do not want this to be reflected as an amendment because it has not been proposed by the Committee.

Mr Andrew (DP) said that in the way Section 44(5) has been constructed it mentions the PPR rules published in February last year. Would it not be better to quote the enabling insurance act as published in case the rules are amended?

Mr Andrew said the implication was that it has already been amended. What if the Minister was to replace the rules entirely?

Dr van Wyk said they could also add "if any are amended".

Mr Wessels accepted Mr Andrew's proposal to quote the enabling insurance act.

Mr Wessels said Members should remember that the pronouncement of the PPR is the exercise of Ministerial prerogative. At the end of the day the Minister may decide to run the two parallel. The Minister may listen to suggestions but ultimately he exercises his discretion.

Clause 45
They need to look at the regulation of all these parties to see that it is not deficient to what FAIS is doing. They also proposed that a code of conduct be introduced. There should not be a deficiency if exempted entities are regulated by another Act.

Health Brokers
The FSB prepared a resume on the inclusion and read the three options available to them. The second proposal; that the conduct of health brokers is to be regulated by the Medical Schemes Council exclusively is not acceptable to the FSB. Neither does the FSB favour dual regulation. Whatever is done under the Medical Schemes Act will not come close to the measures taken by FAIS. There will be no ombud FAIS overseeing health brokers. Health brokers do various things like sell insurance and will then fall under FAIS but not when acting purely as health brokers. This seems very onerous. The FSB invited the Committee to leave the Bill as it stands because the alternative is dual regulation.

Mr Wessels explained that they were proposing the removal of the words "to the extent that the rendering of financial services is regulated by or under those Acts, respectively;" to accommodate the Medical Schemes Council. They thought that the inclusion of the sentence brought all their people, such as medical administrators and so forth, under the FAIS regime.

Clause 45(3)
The Collective Act referred to has not been passed by Parliament yet therefore this is a transitional clause. It may have to be expanded to include the Security Services Act, which is in the pipeline. There may be other changes in contemplation of Acts which will be passed before FAIS is in operation.

Dr van Wyk said it can be included through Schedules or you could already change definitions in anticipation of the Act being passed. They would see what option is the best one.

Clause 46
The target date for promulgation remains 1 April 2002. However, the Minister will still announce a date on which no-one may practice as a financial services provider or representative unless registered under the Act.

Mr Wessels also mentioned that the proposed amendment to the provision for record keeping in the Bill would be withdrawn. The period for holding records would therefore be three years and not five as proposed.

The Committee would commence formal consideration of the Bill the following week Thursday.

Hearings into value of the Rand
Mr Andrew (DP) recalled that last year it was decided to hold hearings into the decline of the Rand, even involving international experts. Since then the Rand has stabilised although the fall has not been reversed. And a Commission has been appointed by the President.

He said that although it was not their view to do the work of the Commission, as a Portfolio Committee they were often marginalised as their work is largely determined by the Executive. Therefore they should be applying their minds to aspects of the fall of the Rand. These kinds of issues included the following. What exchange control regulations apply in SA and who monitors them? On the issue of foreign exchange transactions: what is the magnitude? What is the composition between exports and imports? What is domestic and off-shore? What is the role of the speculator?

Shortly after the 1998 South East Asia currency crisis an IMF committee was set up. What has transpired in this regard? What kinds of trends have emerged? He thought that there were not likely to be agreement on these issues. They would not go into the same details the Commission would examine, largely illegal practices.

He emphasised that Parliament is relevant to issues being discusses all around them, despite the Commission doing some of the work.

Ms Hogan agreed that it would be useful to have such background in preparation for the outcome of the report. Opinions would probably differ. In principle she did not oppose the hearings. However, she would have to take it to the planning committee.

Mr Andrew accepted this. He said that as public representatives they needed to show the public that Parliament is aware of these issues.

The meeting was adjourned.