The National Treasury, with the Financial Services Board, briefed Members informally on the Draft Credit Rating Services Bill to regulate the Credit Rating Agency sector and the Draft Financial Markets Bill to replace the Securities Services Act 2004.
The financial sector had a critical need for regulation. More than any other sector, the financial sector was globally integrated. It was important for
The present Bills could not preempt the changes that National Treasury was going to make in future, but largely addressed urgent gaps. Later, there would be greater distinction in legislation between the prudential and market conduct regulators. National Treasury sought to implement some of the tougher rules needed for alignment with international norms. It was intended to regulate credit rating agencies, as had been done by the
Both Bills had still to be tabled formally. Some of the changes to the Securities Services Act (No 36 of 2004) were so extensive that it was deemed easier to introduce a completely new Financial Markets Bill rather than an amendment bill, even though the basic foundations of the Act would remain intact.
National Treasury contended that there needed to be some accountability of the Financial Services Board to Parliament without breaking the rule of operational independence.
The Financial Services Board emphasised the important of the International Monetary Fund and World Bank's Financial Sector Assessment Programme and efforts to rectify omissions identified and implement recommendations. The Board had received a number of enquiries from foreign jurisdictions on how
The Draft Credit Rating Services Bill was to provide a legal framework for regulating credit rating agencies. There were intentional concerns with the current role of rating agencies. Firstly, credit rating agencies had played a central role in the global financial crisis. Secondly, there was concern at the pro-cyclicality of credit ratings. Thirdly, there was concern at potential conflicts of interest: credit rating agencies provided consultancy services as well as rating services. The Group of 20 had committed itself to creating a globally consistent regulatory framework for agencies, and to reducing the reliance on ratings in legislation. The three main agencies in
Members sought clarity on the function of credit rating agencies, on the role of the Financial Services Board in relation to the Johannesburg Stock Exchange, and on the presentation document's apparent reference only to investors and companies rather than to individual members of the public; and noted that the gap between the haves and the have-nots was widening.
National Treasury acknowledged that there was much confusion about the role of the credit rating agencies which essentially evaluated listed companies and countries and gave them a rating. The aim of credit rating was to protect the investors and investments in pension funds and banks. Credit rating agencies just expressed an opinion on an institution or a country's ability to repay. Whether individuals could make repayments on their bonds was assessed by the credit bureaux governed by the National Credit Act.
A very important part of the Draft Financial Markets Bill was improved measures to deal with insider trading. The main objects of the Bill included increasing confidence in the South African financial markets, reducing systemic risk, and promoting competition in and international competitiveness of securities services in
Members sought clarity on systemic risk and interest rate contracts, and asked what the typical practice worldwide around self-regulatory organisations was. Did National Treasury see anything wrong in allowing the Financial Services Board to regulate the Johannesburg Stock Exchange?
The Financial Services Board explained in detail its role of co-regulation with the Johannesburg Stock Exchange. National Treasury offered to give Members a comparative table to illustrate the various practices for self-regulation that existed in different countries.
The Acting Chairperson said that the Bills offered the prospect of a safer financial sector environment for
The Acting Chairperson opened the Committee's first meeting of the year by noting extensive reporting in the media on insider trading and the importance of ensuring that appropriate regulation was established. The South African Government sought to comply with this noble cause by, among other things, introduction of the two Bills – the Credit Rating Services Bill, which sought to regulate the Credit Rating Agency sector which, hitherto, had largely been unregulated, and the Financial Markets Bill, which was meant to plug gaps in the Securities Services Act that regulated the securities services sector. He emphasised that this was an informal briefing.
Draft Credit Rating Services Bill and Draft Financial Markets Bill: National Treasury Informal Briefing
Mr Ismail Momoniat, Deputy Director-General: Tax and Financial Sector Policy, National Treasury, explained the context of the Bills with reference to the Minister's February 2011 Budget speech announcement of a wide-ranging set of reforms. Details of these proposals were contained in the National Treasury's Policy Document: A safer financial sector to serve
The 'Red Book' had two essential streams of work. Firstly, there was a need to strengthen the institutional architecture of
The Bills could not preempt the changes that National Treasury was going to make in future. Currently all South
National Treasury sought to implement some of the tougher rules needed for alignment with international norms, such as amendments to the Banks Act (No 94 of 1990) which would not even deal with Basel 3 but with 'Basel 2.5f'. In insurance there was a Solvency 2 reform which also tightened the prudential regime. At international meetings, there were many moves to deal with the whole issue of OTC derivatives, as most transactions in derivatives were done over-the-counter rather than through an exchange, so one did not know the risks involved. And then of course, it was intended to regulate credit rating agencies, as generally they had been allowed to operate without any regulation, but now the United States of America (USA) and the European Union (EU) now had legislation in place to regulate the governance of credit rating agencies. These Bills attempted to ensure that the governance of these agencies was free of conflicts of interest, rather than to interfere with the agencies' decisions on credit ratings of companies.
The presentation was to focus on the 'rules of the game', in particular the two Bills to strengthen oversight and regulation of financial services.
Prudential regulators had a critical role to play. All the European Union (EU) countries regulated the governance of credit rating agencies. The aim of the proposed legislation was to ensure freedom from conflict of interest.
The Credit Rating Services Bill was new. There had been no formal regulation of credit rating agencies through legislation previously. Members had been provided with a copy certified by the State Law Advisors.
The Financial Markets Bill was not entirely a new Bill. It was expected to be certified by the State Law Advisors in the next few days. Both Bills had still to be tabled formally.
Some of the changes to the Securities Services Act 2004 (Act No. 36 of 2004) were so extensive that it was deemed easier to introduce a completely new Bill, the Financial Markets Bill rather than an amendment bill, even though the basic foundations of the Act would remain intact. Mr Momoniat humorously pointed out that the Securities Services Act governed securities as in shares rather than in security as handled by the National Intelligence Agency. Indeed, this was one of the reasons for the new title, Financial Markets, to avoid confusion.
Mr Momoniat referred Members to the Explanatory Memoranda on the two Bills.
Mr Momoniat referred Members to Slide 23 and noted that
Members would have heard of the Basel Committee on Banking Supervision. In addition there was the International Organisation of Securities Commissions (IOSCO) for capital markets and the security sector. This brought together the key markets. Such bodies had produced standards with which all members should comply.
Every five years the International Monetary Fund (IMF) and World Bank conducted a Financial Sector Assessment Programme (FSAP) whereby they tested whether
In this regard, Mr Momoniat referred to the International Monetary Fund Country Report No. 10/355 South Africa Detailed Assessment of Implementation of IOSCO Principles – Securities Markets, which noted that
Mr Momoniat observed that it was difficult to ensure coordination of regulators, not only in
Mr Momoniat, referring to Principle 2 and findings in Table 1, contended that there needed to be some accountability of the FSB to Parliament. However, one had to ask how this could be done without breaking the rule of operational independence. Legislation must reflect such independence. The FSB's budget would be dealt with in separate legislation. National Treasury hoped to deal this year with some of the issues which dealt with the financial markets directly. He referred to the findings on Principle 3: 'The FSB lacks regulatory authority to set disclosure requirements for public companies.' Public companies were listed companies. The JSE, as a self-regulating organisation (SRO) was an example of the South African model. However, just because an SRO was self-regulating did not mean that the FSB had no power. This was addressed in the Financial Markets Bill.
Mr Momoniat drew attention especially to Principle 8 and findings, before referring back to the findings on Principle 3: 'This responsibility (for setting disclosure requirements) is assigned the Department of Trade and Industry (DTI) for all companies and to the JSE, which includes disclosure requirements for listed companies in its listing standards. The DTI subsidiaries charged with these responsibilities in 2007 were never operational and have been replaced by new entities, which are not yet operating.'
Table 2 of Recommended Action, on page 15 of the Country Report, under Principle 2, noted that 'The unlimited discretion of the Minister of Finance to terminate senior FSB staff and members of the FSB Board should be defined and limited to circumstances where there is “good cause”.'
Mr Momoniat said the regulatory system would not be fully effective until the Companies Act 2008 (Act No. 71 of 2008) was fully implemented. It then had to be asked, if one had a Financial Reporting Standards Council, where the Accounting Standards Board fell in. These were issues in all countries, not just in
Also other conventions had to be accommodated, such as the UNIDROIT [International Institute for the Unification of Private Law] Convention led by the United Nations.
Mr Norman Muller, Head: Department of Capital Markets, Financial Services Board (FSB), emphasised the important of the FSAP, and efforts to rectify omissions identified by FSAB and to implement FSAB recommendations. The feedback received from the assessor responsible for
Draft Credit Rating Services Bill
Mr Roy Havemann, Acting Chief Director: Financial Stability and Markets, National Treasury, said that the purpose of the Draft Credit Rating Services Bill [B -2011] was to provide a legal framework for regulating credit rating agencies. The Bill provided for:
⚫ the registration of credit rating agencies (CRAs);
⚫ for the control of certain activities of CRAs;
⚫ conditions for the issuance of credit ratings; and
⚫ rules on the organisation and conduct of CRAs, and for related matters.
Reference points were the financial crisis and Group of 20 (G20) outcomes; the International Organisation of Securities Commissions (IOSCO) 'Statement of Principles regarding the activities of credit rating agencies'; other jurisdictions – the EU, the United States of America (USA) and Australia; and EU equivalency requirements. (Slide 7).
Mr Havemann noted the importance of a system of regulation that was equivalent to that of the EU. Firms were quite happy to establish themselves in non-regulated jurisdictions. This Bill sought to regulate such firms by meeting EU equivalency requirements.
The activities of credit rating agencies were currently unregulated. There were intentional concerns with the current role of rating agencies. Firstly, credit rating agencies played a central role in the global financial crisis. Until close to its collapse Lehman Brothers was AAA-rated. Credit rating agencies had a role in exacerbating the current Eurozone debt crisis. Secondly, there was concern at the pro-cyclicality of credit ratings. Thirdly, there was concern at potential conflicts of interest. Credit rating agencies provided consultancy services as well as rating services. This was a particular concern. CRAs played an important role and should be held to the highest standards of rigour and independence. Mr Havemann noted that credit rating agencies were like auditors, in that one placed one's trust in them. Ratings were a cornerstone of other regulation, for example, banks. Thirdly, the G20 commitments were two-fold: to create a globally consistent regulatory framework for agencies, and to reduce the reliance on ratings in legislation. This was a very important component of the proposed legislation (Slide 8).
Credit rating agencies operated globally. The three main agencies in
It was important to ensure that legislation had teeth domestically and was effective. The key challenge was to create a framework where the regulation would have 'teeth' without extra-territorial powers. Under proposed Section 4, 'A regulated person must for regulatory purposes only use credit ratings that are issued or endorsed by credit rating agencies which are registered in accordance with this Act.' For example, this applied to the Banks Act 1990 (Act No. 94 of 1990) – regulatory capital for banks; the Pension Funds Act 1956 (Act No. 24 of 1956) – how pension funds might invest; and the Collective Investment Schemes Control Act 2002 (Act No. 45 of 2002) – how collective investment schemes (CISs) (unit trusts) and money market funds might invest. The implication was that regulated persons had to use registered rating agencies. However, there was no such requirement on private investors, and investors were encouraged to do their own research when making investment decisions. (Slide 11). An outcome of the G20 was that we must no longer assume that a triple A rating was a guarantee that all was well.
⚫ A registered legal entity in South Africa could 'endorse' ratings done by the same agency in another jurisdiction (Chapter 4, Section 18)
⚫ I f the legal entity 'endorsed' ratings, then ratings might be used for regulatory purposes, but the agency was liable for claims
⚫ Compliance function and back-office support could be outside South Africa. (Slide 12).
The Bill's approach to liability entrenched common law. The drafting committee had spent substantial time crafting appropriate liability provision. Unbiased legal opinion was that common law liability provisions were the most appropriate. There was well-established case law on grounds for liability (negligence, maliciousness, that is, normal rules for delictual culpability) and principles for restitution. The proposed Act entrenched common law and did not allow agencies to contract out of liability. (Slide 13).
Mr Havemann noted that the CRAs should not be given such a high level of liability; hence, the entrenchment of common law principles.
Mr Havemann said that the Bill's aim was to promote investor protection (slide 15), and also to the promote integrity and independence of CRAs (slides 16-17). The Bill also aimed at promoting the transparency and accountability of the credit rating industry (slide 18). Each CRA would be required to publish an annual report.
Mr Havemann described the structure of the Bill (slides 19-20).
Ms Z Dlamini-Dubazana (ANC) was confused by so many abbreviations and asked that future presentations include a full index of such terms.
Ms Dlamini-Dubazana referred to Clause 1(1) of the Credit Rating Services Bill and asked if an individual was covered by the definition of person.
Ms Dlamini-Dubazana referred to Table 1, principle 2 (IMF Country Report, page 11) and asked if that would create inconsistency in the Ministerial roles, since executive staff reported to the FSB Board and the Minister had the authority to hire and fire Board Members.
Ms Dlamini-Dubazana asked about Table 1, principle 3 and findings, which were a little confusing.
Ms Dlamini-Dubazana asked, with reference to Table 1, principle 10 and findings, together with principle 2 and findings, what had happened to the Land Bank. Would the proposed legislation apply to the Land Bank?
Ms Dlamini-Dubazana asked with reference to Table 1, principle 8, whose criteria the JSE would use in its surveillance over the listed market, and how effective the FSB was in assessing the Johannesburg Stock Exchange (JSE).
Ms Dlamini-Dubazana asked how the Protection of State Information Bill [B6B-2010] might apply to Table 1, principle 12 and findings.
Ms Dlamini-Dubazana asked for clarity on the lack of reference to individuals in the presentation document. It spoke only of investors and companies. She felt that the answer to her question would be important in preparing for public hearings on the Bills.
Dr Z Luyenge (ANC) appreciated the presentation and asked how the credit rating of a member of the public was arrived at. He was concerned that ordinary people did not have the opportunity of engaging with credit rating agencies, challenge blacklisting, and clear him or herself. Moreover, credit was given mainly to those who already had plenty, and the gap between the haves and the have-nots was widening.
Ms J Tshabalala (ANC), a new Member of the Committee, endorsed Dr Luyenge's concerns, and said that a solution was needed to the problem of the five years' delay that it took to clear a credit blacklisting.
Ms Tshabalala asked if public or private ratings were referred to with regard to conflict of interest (slide 8).
Ms Tshabalala asked if one could regulate the consultancy services of credit rating agencies, since the use of consultancy services might limit opportunities for emerging entrepreneurs.
Ms Tshabalala asked what the operational life span of credit rating agencies was. Was their permission to operate renewable?
Ms Tshabalala asked what the conditions governing annual reports of credit rating agencies were (slide 18).
Mr Momoniat acknowledged that there was much confusion on the role of the credit rating agencies. They were only four in number tended to be international, but with branches in many places (slide 10). The credit rating agencies did not deal with blacklisting, which was covered by the National Credit Act 2005 (Act No. 34 of 2005), which fell under the Minister of Trade and Industry, governed the National Credit Regulator, and regulated the South African credit industry.
Credit rating agencies looked at listed companies and gave them a rating. They even looked at countries and rated them – this had particular reference to government bonds. If a listed company had a triple A rating, it might appear to be safe to invest pension funds there. The aim of credit rating was to protect the investors and investments in pension funds and banks. However, he pointed out that the standard rating agencies were not infallible. For example, the agencies had considered Lehman's Bank the safest in the world, given it a tripe A rating, but subsequently Lehman's had collapsed. Similarly
Mr Momoniat explained that these principles indicated in the IMF Country Report applied to the regulators, such as the JSE and the FSB, not to the Land Bank and state entities. The JSE tended to have the highest standards. It was more the unlisted companies that might present problems. It was important that the independence of the regulators and their ability to operate without interference should be preserved. The Minister was not to be expected to fire FSB Board members for doing their jobs (Principle 2 and findings).
Given this perspective, several questions therefore fell away. Some other questions would be answered by the second part of the presentation.
Mr Momoniat noted that potential conflict of interest needed to be avoided. It was important that credit rating agencies did not give good ratings to a company because it was a big customer.
Draft Financial Markets Bill
Mr Havemann said that a very important part of the Bill was improved measures to deal with insider trading. He noted that in an age of electronic communications, the old definition of stock exchange (as used in a 1985 bill) as a building with the exchange being a room within the building and whereby the Registrar could determine which building was the stock exchange, was no longer valid.
The purpose of the Bill was: ⚫ to modernise South Africa's approach to the regulation of financial markets;
⚫ achieve alignment with the international developments of G20 and the Financial Stability Board, IOSCO, and FSAP;
⚫ align with changes in principles, laws, for example, the UNIDROIT Convention, and international regulatory practices;
⚫ accommodate technical and functional issues; and
⚫ to replace the Securities Services Act 2004 (Act No. 36 of 2004). (Slide 23).
The Bill's process had been exhaustive and extensive. It had begun in 2010 with a review of the Securities Services Act 2004 (slide 24). A further legislative review was expected to begin in 2013 with the prospect of another bill in 2018. It was on on-going battle to keep the legislation up to date with the markets.
Mr Havemann noted the effects of the global financial crisis and an ongoing battle to keep up with the markets.
The main objects of the Bill were:
⚫ to increase confidence in the South African financial markets;
⚫ promote the protection of regulated persons and clients; and
⚫reduce systemic risk; and promote competition in and international competitiveness of securities services in
Issues of Policy and Principle were described: regulatory model/effectiveness (slide 26); investor/client protection and systemic risk (slide 27); central counter-party, financial stability, and cross border participation (slide 28); and the Securities Ownership Register (SOR) and International Financial Reporting Standards (IFRS) (G20) (slide 29). The SOR was especially important. It had been decided to introduce OTC regulation (slide 30). Decisions to regulate over-the-counter derivatives represented an important step forward (graphs, slide 31).
Mr Havemann noted that the availability of food derivatives had helped to ensure that food was distributed all over the world.
Mr Momoniat clarified that the availability of food derivatives reduced exposure to the consequences of crop failures when they occurred.
Issues of Policy and Principle were further described: settlement assurance and certainty (slide 32); regulatory cooperation and competition/ownership issues (slide 33); and limitation of liability (Section 73 of the Securities Services Act 2004) (slide 34).
The powers of the Registrar included enforcement and conducting on-site visits (slide 35).
The Bill provided for the regulation of unlisted securities (slide 36).
The Bill made provisions for the role of foreign participation in markets. The global financial crisis had heightened the need to balance the risks of foreign participation on our markets with the benefits. The powers of the Minister and National Treasury had been enhanced. Regulatory requirements would be determined by the Executive in a manner consistent with broader financial sector and economic policy (slide 37).
The Bill provided for improvements to accountability. The Registrar was required to make public reasons for his or her deviation from the Promotion of Administrative Justice Act 2000 (Act No. 3 of 2000). This promoted good governance and accountability. (Slide 38).
Mr Havemann noted that the Bill took a big step forward in how the JSE regulated itself.
Improvements to market abuse rules included removing two outdated defences (affected transaction and dealing on behalf of a public sector body); creating a new statutory defence: insiders might deal if all parties to the transaction had the same level of inside information and the transaction was not designed to benefit from the inside information; creating an additional insider trading offence: dealing on behalf of an insider, if a person knew that such person was an insider; created an additional price manipulation contravention (contravention of this section was not criminalised): participating if person had reason to suspect that it was a manipulative scheme. (Slide 40).
Other market abuse improvements were that the compensation orders for price manipulation and false statements had been removed, since it had become apparent that it would be almost impossible to identify persons and quantify losses suffered as a result of those actions. Compensation orders for insider trading remained, as it was possible to identify the 'victims'. (Slide 41).
Further market abuse improvements were indicated. Adding a negligence element to the Insider Trading provisions had been contemplated, but following industry comments it was decided to remove this provision. Insider Trading was a criminal offence and it would be too onerous to expect traders to do a full investigation before each and every trade. (Slides 42-43).
There was improved alignment between the Bill and other legislation, in particular:
⚫ the South African Reserve Bank Act 1989 (Act No. 90 of 1989);
⚫ the Banks Act 1990 (Act No. 94 of 1990);
⚫the National Payment Systems Act 1998 (Act No. 78 of 1998);
⚫ the Financial Intelligence Centre Act 2011 (Act No. 38 of 2001); and
⚫ the Consumer Protection Act 2008 (Act No. 68 of 2008). (Slide 44).
Additional provisions (slide 45) and technical and functional issues (slide 46) were described.
Legislative alignment included:
⚫ alignment between the Bill and the Companies Act of 2008 and consequential amendments – mergers included reference to the Financial Markets Bill;
⚫ exclusion from the provisions of the Consumer Protection Act 2008;
⚫ amendment to the Insolvency Act 1936 (Act No. 24 of 1936) to align with UNIDROIT Principles;
⚫ amendment to the Competition Act 1998 (Act No. 89 of 1998) to make provision for the Minister's Certification; and
⚫ removal of reference to the exclusion of the Financial Advisory and Intermediary Services (FAIS) Act (No 37 of 2002) (Slide 47).
The structure of the Bill was outlined (slides 48-51).
Ms Dlamini-Dubazana asked for clarity on systemic risk (slide 27) and interest rate contracts (slide 31). Was there a model for these processes?
Mr E Mthethwa (ANC) asked what the typical practice worldwide around SROs was. Did National Treasury see anything wrong in allowing the FSB to regulate the JSB?
Mr Momoniat replied that different models applied for the SROs. There were different degrees of self-regulation, depending on which aspects were to be self-regulated. There were detailed requirements for listing. There were many details to be complied with in running the JSE, and it was in that capacity that one tended to regulate. Of course, one could argue that once there was a case of insider trading, then other authorities might be required to intervene. In a sense the JSE was like an exclusive club, whose members were all concerned to maintain high standards. There were strong incentives to comply. IOSCO had issued papers on how it was done.
Mr Muller confirmed that there was an IOSCO provision on self-regulation. One could not just allow self-regulation and expect the JSE to just regulate itself. The Regulator - the FSB - resided in Pretoria while the JSE was in Sandton. It was more a form of co-regulation. The IOSCO principle was quite clear and specific that one could not allow just self-regulation if the Regulator did not have all the measures in place pro-actively to address all possible conflicts of interest. So there was a very close interaction between the JSE and the FSB as Regulator. The FSB attended JSE board meetings and assessed it on an annual basis. There was a clear distinction between the role of the JSE and that of the FSB. The main focus of the JSE was to ensure that at all times there was compliance with its rules and its directives. Moreover the FSB must approve those rules to ensure that they were in the interests of protecting investors. The JSE could not take action against a member firm in terms of a contravention of the FSB Act, in terms of insider trading, market manipulation, or misstatements by listed companies, for example, since that was the role of the FSB, although the FSB worked closely on a daily basis with the JSE pro-actively to identify any possible forms of insider trading or market manipulation. Any such cases must be reported to the FSB and the FSB's Enforcement Committee took action, not the JSE. The JSE's role was to enforce its rules on its Members on a daily basis in the first instance. The FSB had a very extensive inspection powers and a strong enforcement process. If the FSB anticipated any contravention by a JSE member firm, it would intervene, in consultation with the JSE, to inspect that member. Thus the JSE was not so much self-regulated as co-regulated. It was not possible to act as a SRO without satisfying the FSB of the ability to fulfill the numerous and onerous requirements as prescribed by legislation.
Mr Momoniat added that this was very important. The JSE was an exchange and not a company. To become an SRO it was necessary to have very high standards. This did not mean that there were not potential areas of conflict. Moreover, the New York Stock Exchange and the London Stock Exchange were also listed on their own respective Exchanges. So it was never possible to take things for granted. He offered to give Members a comparative table to illustrate the various practices that existed in different countries.
Mr Havemann replied that there were a number of options for the model for OTC derivatives. National Treasury would probably follow a phased process. The first step would be to create a reporting requirement. It was to be decided how the Trade Repository would be set up. Since very market sensitive information was involved, it was necessary to exercise care.
Mr Havemann said an interest rate contract was a kind of derivative instrument. There would be a requirement that firms report the amount of interest rate swaps that they wrote. This would be the first step in regulating interest rate contracts.
The Acting Chairperson said that the Bills offered the prospect of a safer financial sector environment for South Africa. Systemic risk was very critical. He outlined key issues with which the Committee would have to grapple: legislative alignment in financial regulation; the need to identify those areas that had to be corrected; the need for joint meetings with other committees; consideration of the liabilities of CRAs; and the views of other stakeholders. This informal briefing had been very informative.
The meeting was adjourned.
[Apologies were received also from Mr N Koornhof (COPE), Mr N Singh (IFP), and Adv S Swart (ACDP). No apologies were received from Members of the DA.]
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