Credit Ratings Services Bill [B8-2012] and Financial Markets Bill [B12-2012: public hearings

Meeting report

Introduction
The Chairperson said that these Bills were a very important contribution to the stability of the financial markets and the economy in general.

Moody's Investors Service submission on Credit Ratings Services Bill [B8-2012]
Mr Jacques Els, General Manager: South Africa, said that Moody's was the oldest bond rating agency in the world. Moody's Corporation, the parent company, was present in over 20 jurisdictions around the world and employed more than 6 000 people worldwide. Moody's had been present in South Africa for over eight years. Its office in Johannesburg currently employed seven people, all of whom were analysts. He referenced Moody's role in capital markets. Rating agencies occupied an important, but narrow segment, in the information industry. Their role was to disseminate opinions about the creditworthiness of, among other things, bonds issued by corporations, banks, governmental entities, as well as pools of assets collected in security files or structured finance obligations. The heart of Moody's operations was expressing opinions on the relative credit risk of long term fixed income debt instruments. These opinions were expressed on a 21 category rating scale ranging from triple A to single C. By making these opinions broadly and publicly available, the rating agencies helped to level the playing field between borrowers and  lenders. More specifically, rating agencies served the market by reducing information asymmetry between borrowers and lenders.

Moving on to the second part of the submission on the Credit Rating Services Bill, Mr Els focused on five areas of the Bill:
▸ the independence of rating agencies
▸ proportionality
▸ liability
▸ third country issues
▸ plain language issues

Mr Neil Acres, Vice-President and Senior Regulatory Officer:  London Office,  explained in detail, mentioning especially that an impact assessment had not been done before tabling the Bill.

Moody's supported the need for such a Bill,  but the extent of the regulatory framework must account for the size of the industry in South Africa.

Scope of application and the endorsement provision
It was concerned that the proposed endorsement framework would impose substantial and unnecessary legal and administrative burdens on the Financial Service Board (FSB) and the credit rating agencies (CRAs) and make it significantly more difficult for financial market professionals in South Africa to access CRA opinions on a diverse range of issues and obligations. This was because the endorsement framework essentially duplicated rather than leveraged the regulation of credit rating services outside South Africa. The Bill presented a number of disincentives for the CRAs to endorse credit ratings into South Africa and if CRAs decided not to endorse those credit ratings into South Africa, the range of debt instruments available to South African investors who used credit ratings for regulatory purposes would be materially limited. Outside the European Union and Japan, no jurisdiction required the endorsement of foreign credit ratings. MIS therefore recommended that the proposed scope of application of the resulting Act be adjusted and that the endorsement regime be replaced with a streamlined recognition system as follows:

▸ limit the scope of the proposed regulatory framework to credit rating services performed in South Africa
▸ permit the regulatory use in South Africa of credit rating produced partly or wholly outside South Africa by external CRAs forming part of the same group as a registered CRA
▸ grant FSB the power to approve or decline a request under the above in whole or affiliate-by-affiliate basis
▸ eliminate requirements for CRAs registered in South Africa to endorse credit ratings produced wholly or partly outside South Africa. 

Civil liability
Moody's proposed an amendment to Clause 19 of the Bill. (See Submission document, page 3).

Criminal sanction
Moody's noted with concern the proposed broad provision in Clause 32. (See Submission document, pages 3-4).
(See Moody's Investors Service Submission document)

Futuregrowth Asset Management submission on Credit Ratings Services Bill [B8-2012]
Ms Olga Constantatos, Credit Access Manager, explained Futuregrowth's shareholding, its specialist areas, assets under management, and gave a background to the discussion on the Bill. She pointed out that all debt was not created equal, but debt was fragmented, conflicted, and non-standard. Bank loans had fewer defaults and higher recovery rates. As to access to cash flow and assets, bonds got paid first (slide 8). Credit was not going away. South Africa was under-geared. Average debt: equity of United States non-financial companies was indicated (slide 9). Bonds were used to match long term liabilities, but 'bond' and 'credit' were now conflated. She explained the relationship between the fiduciary chain and credit ratings agents (slide 12) and summarised Futuregrowth's response to the Bill (slides 13-16) and conclusions (slide 17). 

Ms Constantatos said that concerns around credit would not go away, and that we lived in a world of fear. She referred to Futuregrowth's letter of comments for further details. (See documents)

Association for Savings and Investment South Africa submission on Credit Ratings Services Bill
Ms Adri Messerschmidt, Senior Policy Adviser, gave Members an introduction to ASISA, outlined the ASISA process, explained what a credit rating was, gave ASISA's perspective, and expressed ASISA's concerns around Clause 4 of the Bill.

Introduction to ASISA
ASISA formed in 2008, represented the majority of life insurance companies, investment managers, collective investment scheme management companies and linked investment services providers. It was mandated by members to pro-actively engage with the policy-maker and regulator on policy, regulatory, and other issues of common concern.

ASISA process
In the ASISA process, the organisation collated written comments from members. Members nominated representatives to form part of the Working Group, which discussed and considered comments.

ASISA's perspective
A credit rating was an assessment of the credit worthiness of companies and governments that issued debt. This assessment was based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities, in other words the likelihood of default. A poor credit rating indicated a credit rating agency's opinion that the company or government had a higher risk of defaulting.

ASISA had considered the Bill from an investor’s perspective. ASISA members acted on behalf of investors, who had limited control over choice of credit rating agency, while the actions of issuer and credit rating agency might impact on investments. ASISA members thus supported the objects of the Bill.

ASISA members contracted with clients in respect of exposure limits to credit rating bands. The credit exposure that a client was willing to accept was agreed with the investment manager. Investors took comfort in an independent evaluation of credit exposure in their portfolios of assets.

Larger investment managers employed expert resources to manage credit risk exposures. Procedures and processes were similar to those applied by credit rating agencies. Smaller investment managers might not have access to these resources and might rely more heavily on credit ratings issued by credit rating agencies. From an investor’s perspective, the higher the rating, the lower the perceived risk.

If a credit rating was, for example, downgraded, it could result in forced selling and might cause large losses. The credit rating process must therefore be sound to avoid risk of inappropriate downgrading. It was imperative that credit rating agencies were responsible and accountable. The integrity, transparency and reliability of credit rating process and credit ratings must be protected.

Clause 4 of the Bill
“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.”

This Clause might be misinterpreted to mean that a regulated person must only use credit ratings issued by credit rating agencies and no other ratings. Its intention was to require that where a regulated person was required in the applicable legislation to use credit ratings, those ratings must be issued by a registered credit rating agency.

ASISA's recommendation
ASISA recommended that obligation must reside in the primary legislation to avoid misinterpretation. If the Clause was to be retained, ASISA suggested alternative wording:

“Where a regulated person uses published credit ratings for regulatory purposes, such a regulated person must only use credit ratings that are issued or endorsed by credit rating agencies which are registered in accordance with this Act.”
 
Ms Messerschmidt commented that the credit rating process must be sound to avoid the risk of inappropriate downgrading. It was imperative that the credit rating agencies were responsible and accountable. The integrity, transparency and reliability of the credit rating agencies and process must be protected.  Clause 4 of the Bill was a major concern from the perspective of interpretation. This Clause might be misinterpreted to exclude internal rating processes. The obligation on regulated entities on how they must use credit ratings must reside in the primary legislation. So, for example, if there were regulations for banks on using credits ratings, these should be in the Banks Act. Rules for the use of credit ratings in collective investment schemes should be in the Collective Investment Schemes Act, to make sure that the provision was not misinterpreted. If the provision were to be retained, alternative wording should be used to make it clear that where a person was required to use credit ratings for regulatory purposes, then those ratings must be issued by a registered credit rating agency. (See presentation document and ASISA Submission)

Discussion
Mr N Koornhof (COPE) asked all three presenters if they had had any interaction with National Treasury.

Mr Els replied that Moody's had had the opportunity to meet face to face with National Treasury.

Ms Messerschmidt responded that it had had discussions with National Treasury on two occasions, at least. Its written submission on the first draft bill was also considered.

Ms Constantatos replied that Futuregrowth had not had face to face discussions with National Treasury.

Mr Koornhof asked if ASISA could report progress with its working group.

Mr Koornhof asked Moody's if it would think of leaving South Africa if the Bill was passed in its current form.

Mr Koornhof asked if Moody's, alternatively, would set up in Windhoek a hub for its African operations.

Mr Els replied that Moody's, if the Bill was passed in its current form, would have to review its business model and sustainability in South Africa, given the requirements that the Bill would place upon Moody's as a business.  South Africa was an important market for Moody's, in as much as the rest of Africa was becoming a key focus area for the firm. 

Mr Koornhof asked Moody's how it made its money.

Mr Els replied that there were two models as to how credit rating agencies made their money. The first was 'the investor pays' model. In this model the investor paid the credit rating agency to assign ratings. The second model was 'the issuer pays' model. In this model the issuer (of bonds, for example) as a client approached the credit rating agency   with a request for the agency to assign the client a rating, for which service the client paid the agency. This model prevailed in South Africa.  Moody's as a firm had two divisions. Moody's Investors Service assigned the ratings. There was also a division called Moody's Analytics, which sold subscriptions. There was a  clear distinction between the commercial side of the business and the analytical side to mitigate perceived or potential conflict of interest. This was how Moody's made its money.

Mr Koornhof asked why Fitch, Standard and Poor, and others were absent.

Mr D van Rooyen (ANC) clarified Mr Koornhof's question on why Standard and Poor was absent. He said that Standard and Poor had attended a previous meeting of the Committee and apologised that it would not be able to attend the subsequent hearings, but would send a written submission. This submission had been received (see documents).

Mr Els replied that Moody's regretted not seeing all its competitors in the audience to give more support. It was an important industry that played a vital role in the financial markets.

Mr Els made it clear that whatever comments that he and his colleague, Mr Neil Acres, would make, they were not representing the industry. They were merely acting on behalf of Moody's Corporation.

Mr Koornhof asked if Futuregrowth was big enough to have its own researchers. In a sense it was a credit rating agency, but it was not, to the best of his knowledge, registered. If that was so, was it not unfair of Futuregrowth to attack the credit rating agencies. If Futuregrowth was saying something to the market, he as an investor would listen, but Futuregrowth was completely unregulated. Was that fair, in this market?

Ms Constantatos replied that Futuregrowth's research component was like that of an equity house, and equity houses did their own internal research and they made 'buy, sell, and hold' decisions.  This was exactly what Futuregrowth did, except that Futuregrowth did not look at equities, but  at fixed income instruments. Its own internal credit ratings were really internal 'buy, sell, and hold' decisions, and making sure the risk-adjusted return was appropriate. Futuregrowth's internal ratings were not for external consumption. As an asset manager, Futuregrowth was subject to a variety of regulations. Therefore the Bill would not apply to Futuregrowth because it was not a credit ratings agency.

Mr Koornhof noted ASISA's comment that that smaller investor  did not have the ability of Futuregrowth to have their own research teams. So they would look to the credit rating agencies. However, would they not also look to Futuregrowth. Why did ASISA say that the smaller investors would look only towards the credit rating agencies.

Ms Messerschmidt responded on the smaller investment management companies that might rely more heavily on credit ratings and why they might not look to Futuregrowth. The reason for this was that Futuregrowth was also an asset manager, and also had clients that it needed to report to.  'So it will basically be their competitors.'  So a smaller operation in the investment management industry might not have huge access to the amount of resources that someone like Futuregrowth might have. Therefore they would rely more heavily on credit ratings.

Ms Messerschmidt responded on the losses caused by downgradings or poor credit ratings. She said that Members would note that in her presentation she had used the word 'inappropriate'. Her firm's concern was not that opinions would be changed. They should be changed if the information available required them to be changed. ASISA was rather concerned about the inappropriate changing of ratings, which might lead to client losses. It was therefore concerned that the process must be sound. 

Mr T Harris (DA) supported ASISA's proposal and could hardly imagine any objections to it, as it merely sought to clarify the Bill's intention.

Mr Harris asked Futuregrowth who the four credit rating agencies in SA were. He knew of only three.

Ms Melanie Brown, Managing Director, Global Credit Ratings Company (GCR), the fourth credit rating agency in South Africa, introduced herself (in response to Mr Harris). It had operated for 16 years and was a local agency which focused on South Africa. Her firm had submitted a written response but had not sought an opportunity to present in person, put on record that GCR embraced the legislation proposing to regulate the credit ratings industry, and believed that it would improve the competitive landscape and whilst the other agencies would certainly be in a position to benefit from a number of exemptions, all credit rating agencies were required to apply for a licence and go through the vigorous due diligence in order to obtain the licence. At the end of the process, GCR hoped to have earned its licence, creating a level playing field with the other credit rating agencies, thus broadening its market. GCR did not believe it was the intention to downsize the credit ratings industry and thought that a balance would be found between providing the market with a higher level of transparency, while also applying a balanced approach. With the current draft Bill as it stood, the risk of not being able to employ or retain analysts was high, due to the onerous liability clauses in the draft Bill. GCR pointed out its key concerns and recommended changes. (See Global Credit Ratings submission.)

Ms Constantatos replied that there was a fifth - Ratings Africa, which was fairly new.

Mr Harris remarked that the credit rating agencies governance model worked so well because it was global (see slide 14). The agencies spread risk and accountability across the globe, and obtained a diversity of opinions, and formed teams on an ad hoc basis to consider various accounts and ratings. In the context of credit rating agencies this was good practice. He had a concern about dedicated designated key individuals as this would compromise the agencies' global spread. This was unworkable and would increase risk.

Ms Constantatos replied that introducing key individual accountability might prevent some of the global knowledge and opinion. This did not preclude ratings committees that were staffed by overseas members. Key individual accountability just said that there was somebody in a local context and local jurisdiction who took responsibility for the opinions issued by that corporate entity. Futuregrowth would not wish to get rid of the international perspective that credit rating agencies used in their international ratings committees. 

Mr Harris was confused by the argument (slides 15 and 16) about the processes that Futuregrowth was proposing. He understood that these were processes that Futuregrowth would apply in its own internal operations. He did not see the need to legislate this proposal. It was surely good practice on the part of issuers of debt. It was Futuregrowth's responsibility to advise its clients or set up its structures appropriately. He referred specifically to the proposals around the audit committee. Surely this was an internal matter.

Ms Constantatos replied that Futuregrowth's proposal supported the independence of the ratings agencies in that it inserted a level of governance, particularly on the audit committee, and removed potential conflict, particularly as regards to management. Futuregrowth agreed that balance was needed. Futuregrowth's proposal supported the independence of the rating agency to issue its opinion without being affected by revenue concerns that it might lose a particular mandate, if the rating agency downgraded its opinion. Futuregrowth reiterated that it supported the 'issuer pays' model and did not support the 'investor pays' model. The example of the auditors was very apt.  

Mrs Constantatos responded that the investor market was particularly fragmented. It was very difficult as an investor to insist on these terms when there were perhaps other investors who might not see them as being especially important or see their potential values. There was very little protection for investors in public capital markets. In relying on internal processes there was not that negotiating power for investors. 

Mr Harris asked Moody's more about its alternative model for endorsement, particularly in other markets, and specifically in smaller markets.

Mr Harris would appreciate advice from Adv Frank Jenkins, Senior Parliamentary Legal Adviser, on the scope of the definitions in 'this Act' (the Bill, page 5).  He noted that Moody's feared that the definitions' scope would lead to circular arguments. The definition of 'this Act' was too broad.

Mr Harris asked about the plain language provision (the Bill, page 5). He understood Moody's concern, but noted that the provision was for plain language, meaning that the person of the class of persons for whom a credit rating was intended would understand it. Surely Moody's view that the plain language provision would add an element of risk because credit ratings were intended for investment professionals failed to recognise that the plain language provision was in terms of the plain language that would be used and understood by such investment professionals.

Mr Harris asked for a view on an international comparison on a code of conduct. Were there similar structures established in other markets. What were the specific risks of the model on the table at present?

Dr M Oriani-Ambrosini (IFP) shared Mr Koornhof and Mr Harris' concerns.

Dr Oriani-Ambrosini sought Moody's help in understanding beyond page one.

Dr Oriani-Ambrosini had two concerns of principle. It had been inculcated in his mind that it was impossible to regulate the freedom of opinion. Everyone had the right to his or her opinion, and to express it, up to the point of defamation. Here one was setting up a system to regulate who could express an opinion, how that opinion should be expressed. He had difficulty understanding the distinction between the regulation of form and the regulation of content. There was no way, constitutionally, that one could regulate the content of an opinion. In the Bill there were four levels of provision. These were the law and regulations, the directives, and the practice notes. He asked how he could satisfy himself that this Bill was constitutional, given such power to regulate an opinion. 

Dr Oriani-Ambrosini's second difficulty was that this Bill was all about accountability.  He accepted that the proponents of the Bill were following an international model, one which had been adopted in other countries. However, he wanted to look at accountability from a fresh perspective. Those who issued a wrong opinion should be held accountable, if they issued such opinion in a negligent manner.  One was considering a mechanism of accountability from the viewpoint of how the rating agencies did their work, not in terms of outcome.

Dr Oriani-Ambrosini asked the presenters how they would react if they were constantly to be asked how they got it wrong. A firm had filed for bankruptcy while enjoying a triple A rating from a credit rating agency. If members of the public relied on these opinions, and at the same time one created for these agencies a virtual monopoly or cartel, because those who were not so registered could not give such opinions, it would become illegal to set up a business which gave such opinions. Therefore, given such a monopoly, why should these firms not be held accountable, like other professionals, in cases of negligence?

Mr Els replied that one needed to remain mindful of what in fact were put out in the market as opinions. What Moody's issued as an opinion was its opinion. Moreover, people tended to differ in their opinions. Therefore there should not be an overall reliance on ratings. Ratings should be used to the extent that investors felt comfortable. Moody's was mindful that it was ultimately pensioners' money that was invested in those funds. 'It's an opinion and should not be overly relied on.'

Ms Messerschmidt agreed with Dr Oriani-Ambrosini that a credit rating was an opinion, but it was an opinion that was relied on ultimately by the ordinary citizens of South Africa. It was Government's responsibility to protect the interests of those ordinary citizens who relied on these opinions. She was not saying that there should be no regulation of opinion. Rather she was saying that there should be appropriate regulation of opinion.  

Ms Olga Constantatos agreed that the issues around regulation of opinion were tricky. Perhaps the role of credit agencies could be likened to the role of auditing firms, which were also required to be accountable to their users. They were reliant on management information and sometimes got it wrong.  Futuregrowth sought much more accountability in the issuing of an opinion.  

Ms J Tshabalala (ANC) asked about the obligations of the credit rating agencies.

Mr Els replied that it was important to draw two distinctions. There were two types of losses that could occur. The first loss was when an investor actually suffered a loss because a bond which the firm rated ultimately defaulted, regardless of what the firm's rating was at the time. The first type of loss was an investor loss on the back of a downgrade.  If an issuer defaulted on a bond, it meant that it could no longer repay its debt obligations. It meant that either it could not service the interest payments, nor the principal, or neither of those. Hopefully, in time, the firm's rating would reflect that credit position.

Mr Els replied that it was important to draw two distinctions. There were two types of losses that could occur. The first loss was when an investor actually suffered a loss because a bond which the firm rated ultimately defaulted, regardless of what the firm's rating was at the time. The first type of loss was an investor loss on the back of a downgrade.  If an issuer defaulted on a bond, it meant that it could no longer repay its debt obligations. It meant that either it could not service the interest payments, nor the principal, or neither of those. Hopefully, in time, the firm's rating would reflect that credit position. He replied that the second loss was where a rating downgrade could potentially result in a loss. This distinction was important. If an issuer was downgraded to a rating level which was below the minimum prescribed in that internal investor mandate the portfolio manager would sell that instrument out of the specific portfolio. That was purely an internal requirement on the part of the investor. It was a decision based on their mandate and on the basis of the rating, but it was an internal decision that was taken to sell the instrument. Given the fact that markets and prices moved, that was an instance where a portfolio manager or an investor might suffer a loss, given that a rating had been downgraded. The distinction between this type of loss and the first type of loss was that in this case, the fact that a rating had been downgraded did not mean, in most instances, unless downgraded on a default basis to a single C, in all other instances it probably did still indicate, although a downgrade had taken place, that the issuer could still repay that interest and principal, but merely that as a rating agency, the firm saw the perceived relative credit risk as higher than deemed before. 

Ms Tshabalala asked Moody's to say how it would respond to the assertion that credit rating agencies must be held accountable and responsible. 

Mr Els replied with reference to the comment that a poor rating posed a higher risk and might cause large losses.  This was a comment made by ASISA and Moody's could not take responsibility for it. He clarified that a higher rating, in Moody's view, posed a relative higher credit quality, in the case of an issuer or a bond instrument.

Ms Tshabalala asked Moody's how it generated its income, and sustained the company.

Ms Tshabalala asked Futuregrowth (slide 10) how it recovered money.

Ms Constantatos replied that Futuregrowth sought to make a risk-adjusted return. So if Futuregrowth loaned somebody R1 million, the rate of return that  Futuregrowth would require back would depend on the risk that Futuregrowth saw in that corporate. Futuregrowth would require a much lower risk-adjusted return in the case, for example, of a water board, than it would for a start-up entity with unstable cash flows. It was important that Futuregrowth did not seek these returns for its own account but for the funds that it managed, since the investors of these funds expected an appropriate rate of return on their investments.

Ms Tshabalala asked Futuregrowth to elaborate on its views on how lenders could replace credit rating agencies by performing the latter's functions themselves. To whom, in this situation, would the third-party lenders be accountable?

Ms Constantatos replied that effectively Futuregrowth acted for the lenders. 'We act for the funds that effectively lend the money.'  There were trustees of the various pension funds who put together, in conjunction with Futuregrowth, a mandate, and they agreed on a risk profile for that particular mandate. The fund of people about to retire had a different risk profile from a fund for people who were young and just starting their careers. So there were very different risk mandates that were negotiated. As asset managers, Futuregrowth was accountable to the trustees that appointed it, and in the final analysis accountable to the fund members whose money Futuregrowth was managing.

Mr Van Rooyen was confused by Moody's apparent contradiction of its commitment in its presentation. What did Moody's mean by saying that the independence of credit rating agencies would be compromised by the form of disclosure on rating standards. It was key for the registrar to know and understand what methods and procedures were employed in order to come to this determination of fair standards and determine the transparency of the rating agency.

Mr Acres replied that Moody's concern was with the way in which the Bill had been drafted.  It was concerned that the regulator had the ability to publish rules on the methodology or on the assumption. Because a rating was the firm's opinion, Moody's believed that it needed to have control over that opinion. If there was any perception, internationally, that the regulator was interposing himself or herself, in the firm's opinion, that opinion would then be seen as the policy maker or regulator's opinion, rather than the firm's opinion. In the case, for example, of sovereign debt, this would become more acute. It was most important that a credit rating agency was seen to be independent of the government that was issuing that debt.

Mr D Ross (DA) found the ASISA perspective quite correct. It was imperative that the credit rating agencies were accountable and responsible, and their processes transparent.

Mr Ross had a problem with the Futuregrowth presentation. Accountability and transparency seemed to be set against independence. It was therefore important to find out what balance could be found. If investors sustained huge losses, that could be very negative for pension funds. Therefore Futuregrowth should seek more responsibility from the credit rating agencies. This needed to be addressed in the Bill. In promoting accountability and transparency, it was necessary to respect independence. However, if there was too much independence, if there was bad news, it could create problems of real losses for real people.

Mr Ross asked Mr Neil Acres to ensure finding a bona fide approach on all occasions, so that members of the public, including the pensioners, could be sure that the rating was in good faith. One did not want to encroach on the credit rating agencies' independence but one wanted to find a balance in terms of responsibility.

Mr Neil Acres discussed the issues of endorsement, plain language, and the code of conduct.

Mr Acres said that there was a provision in the Bill which defined external ratings. That definition would allow the registrar to make a determination as to whether that external rating agency which was based offshore was subject to regulatory requirements which were similar or as stringent as those in South Africa. So, Moody's view was that, instead of introducing a specific endorsement requirement whereby one had to endorse every single rating into South Africa, if the registrar was comfortable that, for example, Moody's entities in the United States or in the United Kingdom were subject to a regulatory framework with which they were comfortable, then Moody's should be allowed to use ratings that were assigned by that specific entity. If, for any reason, there was a breach of the regulations, the regulator could take comfort in that foreign jurisdiction that the regulator in that foreign jurisdiction would make sure that necessary action was taken. 

Mr Acres agreed that the plain language should be appropriate for those for whom it was intended. The provision in the Bill to express ratings in clear language already existed. The plain language provision was perhaps something of a red herring in terms of suggesting that there should perhaps be an alternative level of language that should be adopted at the retail level. In response to this requirement, Moody's would have to state in its opinions that every opinion was directed to a financial market professional. Moody's thought it unnecessary, given the other provisions already in place.

Mr Acres said that the Bill's proposed code of conduct related to the IOSCO code of conduct. The principles were largely aspirational. If there was non-compliance in certain areas, there was a requirement for the credit rating agency to list those areas of non-compliance. It became very difficult when that kind of aspirational language was transcribed into a legislative standard, as it was difficult to comply on an exact case by case basis.  It was a very high level principle. So Moody's was not against having a code of conduct, but did not believe that the full wrath of enforcement and measures that would be available in breach of a regulation should necessarily be applied to a code of conduct as well. 

Mr Acres replied that it was never his firm's intention that it should never be held liable. However, it had a concern that liability might be linked to a wrong or incorrect rating. For example, if his firm were to downgrade a AAA rating to the level below, did this mean that the original rating was wrong? This was not necessarily so. What was important was that credit rating agencies followed their methodology. It would not be appropriate, however, to attach liability to the ultimate rating results.

Mr Jason Lightfoot, Portfolio Manager, Futuregrowth, added that the problem with the 'issuer pays' model alluded to by Mr Els was the ability to fire the agency if a downgrade was imminent.

Mr Lightfoot said that currently there was R1.2 trillion listed as debt on the JSE and it was necessary to protect the man on the street. 

Mr Lightfoot added that Futuregrowth supported the growth of credit rating agency industry.

Ms Brown referred to Ms Constantatos' comment that no agency gave a rating lightly. However, much depended on management information, as well as fundamentals driving the industry. There were many unknown factors. It was basically a collective of minds in forming an opinion. Much work and analysis was involved. There was something of a stigma in being a local agency, but Global understood the market very well. However, it could never survive an Enron, for example, and had to be very careful and specific in according a rating to ensure that whatever rating came out into the market did not prejudice Global's reputation. Global was almost self regulated. 

The Chairperson could not allow a second round of questions and responses because of a lack of time.

Financial Markets Bill [B12-2012]
The Banking Association of South Africa submission
Mr Mark Brits, General Manager: Financial Markets, conveyed the apologies of Mr Cas Coovadia, Managing Director. Mr Brits said that financial sector regulatory reform was taking place across the globe. The Financial Markets Bill updated G20 commitments. The Twin Peaks was to provide regulatory architecture for South Africa, and establish South Africa as a Financial Centre for Africa.

The self-regulatory organisation (SRO) model
He discussed the self-regulatory organisation (SRO) model with reference to managing conflicts of interest, limited liability provisions, commercial interests, and global trends.

Strengthening the Bill:
He discussed robust management of conflicts of interest provisions; formal mechanism for market participants to raise concerns and complaints with the Regulator (Registrar); external review of conflict management processes; and clear separation of regulatory and commercial activities.

Regulation of Over the Counter (OTC) derivatives
▸ Local registration requirements
▸ International financial market infrastructures
▸ Cost vs. benefit analysis
▸ A measured approach to implementation
(See presentation document, Ethicore Letter, and the Banking Association of South Africa Submission)

Cyprus Legal and Commercial submission on Financial Markets Bill
Mr Felix Majoni, Managing Director, submitted that there was therefore a great need to properly regulate the financial markets. A primary objective of financial market regulation was the pursuit of macroeconomic and microeconomic stability. Safeguarding of the stability of the system translated into macro controls over the financial exchanges, clearing houses and securities settlement systems. Measures pertaining to the micro stability of the intermediaries could be subdivided into two categories i.e. general rules on the stability of all business enterprises and entrepreneurial activities, such as the legally required amount of capital, borrowing limits and integrity requirements; and more specific rules due to the special nature of financial intermediation, such as risk based capital ratios, limits to portfolio investments and the regulation of off-balance activities.

A second objective of financial regulation was transparency in the market and in intermediaries and investor protection. The evolution of financial markets had been particularly significant in the last decades with regard to intermediaries, capital markets and financial instruments. Structural changes had mainly involved the more traditional financial operators in banking, but had also involved investment firms and insurance companies. A number of countries (the United States, the United Kingdom, Australia and Japan) were in fact presently radically changing their regulatory systems.
(See Cyprus Legal and Commercial Submission, pages 2-3).

There were several supervisory models traditionally used in the regulation of financial markets. These were: institutional supervision, supervision by objectives, functional supervision, and single-regulator supervision. (See Cyprus Legal and Commercial Submission, pages 3-4).

After the global financial crisis of 2009-2010 and the recent Eurozone crisis, regulatory authorities were now been treating financial markets with caution and close scrutiny. It was necessary, however, to learn from these catastrophes and see how to align South Africa's own financial markets to the banking sector as both were interconnected. A good example (though part of the Eurozone Crisis) was the Italian Financial System.

Banking, securities and insurance segments were becoming increasingly integrated in terms of markets, intermediaries and financial instruments. The boundaries separating banking, securities and insurance activities were in fact on their way out in most developed financial systems because of the strong process of technological, geographical and functional integration among these three sectors; and as a consequence of the de-specialization of the intermediaries.

The regulatory arrangements in the Italian financial system - integration among intermediaries, markets and instruments – were explained.  (See Cyprus Legal and Commercial Submission, pages 4-6).

While the South African Financial Markets regime was currently regulated under the Securities Services Act, there was market segmentation in so far as the financial system was concerned. There was differentiation between the regulation of banks (mainly under the Banks Act), Insurance Companies and securities. There was a plethora of legislation that was not interlinked in ensuring that these crucial players in the Financial System were in perfect equilibrium. The proposed Financial Markets Bill sought to regulate members of clearing houses (sections 75 & 76); prevent market abuse such as insider trading (section 80 and 84), self regulation (sections 59 – 73) and licensing. It would be ideal to align issues such as licensing to already existing measures governing licensing of financial sector institutions such as banks and insurance companies. There were currently several licensing authorities such as FAIS, FICA, Insurance Ombudsman, Banking Ombudsman, Licensing of Compliance Officers, various licenses under the Banks Act etc. The Bill had to be aligned with the already existing licensing procedures in place in a similar model. The regulation of Financial Markets in South Africa did not have to be isolated from the rest of the financial services sector as such was part of the financial sector especially banking. Most of the securities transactions were done through banks when they matured and yielded hence the Banks Act and the Financial Markets Bill should be closely aligned so that one did not face problems of systemic risk or asset bubbles. One had learnt from the global crisis as well as the Eurozone crisis so those experiences should always assist in crafting the Financial Markets that one wanted.

The regulation of South Africa's financial markets should be premised on regulatory objectives based on stability, transparency and proper behaviour and competition. Institutions regulated by the Financial Markets Bill should also inter alia include mutual banks, investment firms, Investment Funds or in addition to the definition of a bank, be defined as a Bank in terms of the Banks Act as the definition of a bank in the Bank’s Act included a Mutual Bank. (See the Cyprus Legal and Commercial Submission, pages 6-8)

Johannesburg Stock Exchange submission on Financial Markets Bill
Mr Louis Cockeran, Legal Counsel, submitted that it was of the utmost importance to define correctly the duties and functions of a self-regulatory organisation (SRO) in the Financial Markets Bill as that had to be clearly distinguished and differentiated from 'securities services' that were provided  by the authorised user of SROs. Put differently, SROs did not provide securities services nor should they be allowed to provide securities services a SROs exercised regulatory duties and functions as contemplated in the Financial Markets Bill. Furthermore, neither a central securities depository (CSD) nor a Clearing House was capable of performing 'securities services' as defined in Clause 1 of the Financial Markets Bill. The JSE asked that the CSD and Clearing House chapters be amended to be consistent with the exchange chapter. (See JSE submission, paragraphs 2-6).

The JSE also sought an amendment to Clause 82(1) and (2) on market abuse to include 'reasonably ought to have known' as part of this offence. The ambit of this definition should also  be expanded. The JSE also proposed amendments to Clauses 82(3)(a) and 84(1). (JSE submission, paragraphs 7-19). It made editorial comments on Clause 34(2)(r), Clause 103(2)(b), and the consequential amendment to the Insolvency Act, (See JSE submission, paragraphs 20-22).

Discussion
Mr Koornhof said that the Financial Markets Bill was, for Members of Parliament, new territory. He hoped that those concerned were not rushing the matter. He asked the presenters if they felt that the process was being rushed. Secondly he asked if South Africa would be turned upside down if the Bill were not passed in the next six months.  He asked if those who had made submissions needed more time to interact with the Committee and with the National Treasury.

Mr Brits responded that the apparent rushing of the Financial Markets Bill was a concern for the banking sector. Much of the detail would be kept in the regulations, which would expand the thinking behind the Bill.  
If the Financial Markets Bill was not enacted immediately, the result would depend on how long it would take to enact the Bill after this process, which would determine whether one could survive or not. If this Bill were not enacted in the near future, one would survive until the next round. He said that he would call upon some of his more learned colleagues in the banking sector to respond to certain more technical questions. They would be expected to introduce themselves as the baton was passed on.

Mr Cockeran replied that the JSE had been consulted extensively and would be satisfied if the Bill were passed in its current format. The JSE had interacted regularly with the National Treasury.

Mr Koornhof was a little concerned about the Italian model. Italy's banking system was definitely not an example to the rest of Europe. So he failed to understand that little case study. He asked the Banking Association if it was happy that South Africa moved towards the Italian model.

Mr Brits said that the Global Competitiveness Report rated the banking sector of South Africa number two in respect of the soundness of its financial markets. He was not sure how the banking sector of Italy ranked. However, South Africa had an exceptionally good regulatory environment, and he would not want to change that to another model. However, that was a matter of policy for the South African Reserve Bank (SARB). 

Dr Z Luyenge (ANC) asked all presenters a cross-cutting question, noting their concern that South African financial markets were in order and remained competitive throughout the globe. Did the presenters have any working relationship  and how often did they interact with National Treasury on matters that affected the financial markets, not necessarily on certain matters related to a bill in process.

Mr Brits confirmed, on the working relationships that Dr Luyenge had raised with relation to National Treasury on South Africa's markets, that the Banking Association had very engaging working relationships with National Treasury, which had asked the right questions and had indicated that it would continue to engage the Banking Association on matters pertaining to this Bill, and particularly on OTC derivatives. It was not unusual for such a complex piece of legislation to require a fair amount of technical assistance to understand these matters and the Banking Association respected that the National Treasury would make policy based on the collective intellect gleaned from some of the Banking Association's presentations. 

Mr Ross shared Mr Koornhof's concern and hoped that this legislation was still in its founding stages.

Mr Ross said to the Banking Association, in terms of international best practice, on the SRO model, that South Africa was not committing to international best practice. Powers had been extended in terms of powers and responsibilities. This was a huge concern and much work remained to be done before debating in detail.   

Ms Tshabalala commended National Treasury for the discussions that it had held.

Ms Tshabalala, looking at the Banking industry, could see the issue of the investor and the client protection being taken to account in the Bill specifically around the protection against market abuse. However, the Banking Association, in its presentation, had not followed around the issue of the G20 about which  it had raised some concern. Did this have something to do with the alignment with international developments or practices? Also what was the downside of the G20 matter?

Mr Brits said that in terms of international best practice South Africa was committed by its G20 participation to adopt the legislation that was drafted by the international standard centres. As a result, South Africa was almost placed on a time-line of the international community and would have to meet those requirements. This was something on which the Banking Association's policy makers would deliberate on and determine whether it was appropriate for South Africa. At the moment, both the banking legislation and the legislation pertaining to the financial market crisis were upon South Africa and were being committed to. The initial requirement for OTC derivatives was for there to be something in place by the end of 2012 in terms of legislative framework. The Financial Markets Bill gave evidence to that  commitment, whereas the Banking Association was under the impression that National Treasury would take a slower approach to the implementation of these suggestions for regulating OTC derivatives post the end of 2012. 'Our commitment is there.' 

Mr Brits said that the reflections on market abuse and the G20 status were something that had already been covered by the adoption of the G20. The banking sector was mindful of the market abuse provisions and the needs of South Africa in extending its reach. So once again that became a process as one evolved our legislative frameworks to incorporate those matters, and the Banking Association really did not have any influence over those policy decisions. However, the Banking Association certainly had processes in place to ensure that market abuse was something that it was focused upon. In the Bill there was a Clause that related to market abuse. A reflection on that might give a fair indication of how important it was to the banking sector and to South Africa's financial markets in general.  

Mr Van Rooyen noted that Ethicore placed emphasis on the need to draw a line between South Africa's domestic OTC derivatives and those of international markets. In the light of the intense competition in the international markets, he was not sure if this approach would really allow South Africa to be an attractive destination if South Africa regulated differently from other markets.  

Mr Brits said that, with regard to OTC derivatives and the domestic market, his learned colleagues had argued that policy was in the Bill, and that already the  Bill was straightforward in terms of its requirements for local registration. The Banking Association believed that it was different in its approach on this particular matter and believed that although policy could be made in the proposed Act the application of those policies was more suited to be done in the regulations. The Banking Association would like to see the Banking Registrar have as much power as his or her disposal as a policy to enable over the counter clearing of foreign jurisdictions. He would defer this to his learned colleagues to reflect upon. 

Ms Tshabalala asked Cyprus Legal and Commercial if the firm was not comfortable with the existing level of efficiency and effectiveness in supervision.

Mr Van Rooyen asked Cyprus Legal and Commercial what was the exact intent of its presentation, which called for alignment between services but was not clear on having one ombudsman. 

Mr Majoni said that there was now a plethora of legislation which made reference to an ombudsman, for example, the Insurance Act and the Banks Act. His proposal was to address the issue of how an ombudsman used to dealing specifically with insurance matters supposed to deal with issues peculiar to financial markets, should there be a dispute. He proposed an all-embracing code of conduct to regulate all the ombudsmen, as their were certain issues that these ombudsmen were not used to.  

Mr Majoni said that the SARB should take a leading role in supervising financial markets, because it was the lead regulator as far as banking was concerned. 

Mr Harris asked all the presenters if they felt that this Bill was sequenced correctly with the move towards the Twin Peaks framework, for example, the assignment of many more responsibilities to the FSB. Was this something that we should be doing at this point?  Or should we move closer to the Twin Peaks model in general and then move into the details of a law like this?

Mr Brits said that the sequencing with Twin Peaks and the additional responsibilities gave rise to a concern in the banking sector that the Twin Peaks programme had not yet manifested itself. The Banking Association supported the process, while understanding that in the Corridors of Power there were processes under way in which a number of committees had been established to review the Twin Peaks programme. The Banking Association was under the impression that once the structure had been finalised regulators would be appointed and they would be tasked with ensuring that the regulations were fit for the intended purpose for their structures. Whether this was an appropriate approach was challenging. However, the Banking Association was supportive of the fact that this process was already a long way on the track, and whether the Financial Markets Bill gave evidence to that ahead of the Twin Peaks process the Banking Association believed that there would be some challenges but this was something that could be worked out through the policy process. 

Mr Harris asked what the position of South Africa was, relative to the other G20 markets, in tabling a Bill such as the Financial Markets Bill? Was South Africa leading the pack?

Mr Harris asked around the SRO model, from which globally there was a shift away. However, this Bill gave the JSE, which ran the market and had a commercial interest, regulatory powers, without perhaps providing sufficient controls to prevent conflict of interest. That suggested that perhaps the FSB should be given a stronger role and regulatory responsibility.

Mr Harris was interested in how much Parliament had put into the law as opposed to what was left to delegated legislation – the regulations. The draft before Members was silent on Central Clearing Houses. This raised an important question as to whether South Africa was big enough to sustain a Central Clearing House or whether South Africa needed to establish some kind of equivalence framework, as the Australians and the Canadians had done.

Dr Oriani-Ambrosini found this Bill quite complex, because he was confronted with things that he knew that he knew, things that he knew that he did not know, and things that he did not know that he did not know. This was unusual in a piece of legislation. It was a matter of understanding the Bill, and understanding the subject matter to which the Bill applied, much of which, in the presentation which Members received, made references to things which fell within self-regulation, banking practices, and the way things were done. Members were squeezed between what were portrayed to them as international imperatives. For example, South Africa had made a commitment to the G20. Irrespective of its merits South Africa was bound to follow the G20. On the other hand there was technical negotiation which took place with the National Treasury, where in-depth discussions took place between people with greater knowledge than Dr Oriani-Ambrosini's own. At the third stage there was the regulatory environment, where all the substance really happened when the regulations were issued.  This made Dr Oriani-Ambrosini ask himself what Members needed to do, and what he needed to do, to be able to convince himself that he was doing his job as a legislator correctly. 

Dr Oriani-Ambrosini asked if it would not be possible for the Banking Association to provide Members with a larger, workshop space, in which Members could ask questions in a more interactive manner. 

Mr Brits said that the Banking Association would welcome the opportunity to offer a workshop as suggested by Dr Oriani-Ambrosini.   

Dr Oriani-Ambrosini had difficulty in understanding the entire issue of the derivatives, as utilised exclusively to transfer risks from the insurance sector onto the banking sector. The presenter (which one?) had said that this was because the banking sector was more equipped to handle that. An example came to mind, where the same derivatives were housed within the insurance company, and then these derivatives became toxic assets. 

Dr Oriani-Ambrosini was trying to understand why the banking sector would be more suitable to handle what in the end was a liability, unless the banks carried liabilities as assets and on that basis multiplied in terms of lending ratios.    

Mr Brits said that when it came to the question of whether one was adequately supervised, South Africa's Bank Regulator, in terms of the banking sector, had received many accolades in terms of its ability to regulate the Banking Sector. The Regulator had had an influence over the soundness and safety of South Africa's banking sector. The banks themselves had implemented very robust risk management processes that had allowed the South African banking sector to avoid the crisis that had manifested itself internationally. This was a credit to South Africa's banking sector. 

Mr Brits said that, with regard to the G20 process and South Africa being a smaller country, the Banking Association  was very mindful that South Africa had a world class banking sector, and at the same time had some very large and trying social issues that must be addressed. The Banking Association did not take this lightly. In all engagements with regulators and policy makers, the Banking Association made the point that South Africa was a small country. With OTC derivatives it might be possible that the solution provided by the United States and Europe was somewhat of an over-kill.     

Mr Brits said that the SRO model, in terms of conflict of interest, and a stronger role for the FSB, were things that could be considered. The Bill was the appropriate place to do that. How much should be put into law and how much into regulation was once again a balancing act between the enabling Act and the regulations which gave effect to that enabling. 

Mr Brits could not answer the question on whether South Africa was big enough to establish a Central Clearing House. There might be some merit to development of a local clearing facility. If South Africa lacked the capacity to do so it might look to using an international counterpart.

Mr Brits said that the Banking Association, in connection with derivatives, talked about transferring risks from the insurance sector, not to the banking sector, but to those people better equipped to manage those risks. The banking sector was one of those entities that specialised in risk management.

Mr Brits said that toxic assets was a term that had been used in the United States with specific implications for the United States Market. In South Africa there were not the same concerns. Its products were considerably more 'vanilla' in their approach in comparison with the complex products of other countries. However one learned from the lessons of the international community.

Mr Brits said the banking sector was the best manager of risk in South Africa. Whether a bank accepted them, or packaged them, or passed them on was something that the bank concerned would explain to a client. 

Mr Colin Iles, Chief Operations Officer: Markets Africa, Absa Capital, said that the Bill was important for South Africa and was very much related to ensuring that South Africa had competitive markets and that local institutions got the financing that they needed for their businesses.  However, the existing legislation and relationship between service providers was strong. So he did not think that there were any particular problems in the short term. The danger of rushing the legislation, and making South Africa perhaps over-regulated compared to other countries, was that South Africa might make itself less appealing internationally.  At the same time he hastened to add that the Bill in its present form was not heading towards those particular issues. However, many in the sector might support more discussion.

Mr Iles said that the sector received sufficient supervision from the SARB, which did an excellent job in understanding the risks and exposures that the banks were subject to. 

Mr Iles said that the sector was  impressed with the level of oversight that the Financial Services Board was pushing through. One of the issues that the Board raised was whether the level of oversight was sufficiently enshrined in the proposed legislation or whether one was placing reliance on people and mechanisms outside the legislation. 

Mr Cockeran replied that the JSE was aligned with the best practices of the G20.

Mr Cockeran replied that there were different views on how to regulate OTC derivatives. The United States and Europe had divergent views. It was firstly  important to determine the size of the market.

Mr Cockeran said that the JSE had existed for 120 years. The courts had decided on disputes many times. The first was in 1914 when the JSE had misused its powers. It had been taken to task subsequently and lost each of the five cases in the past 100 years. The Appeals Board existed to deal with any aggrieved parties who were not satisfied with any action taken by the JSE or by the Registrar. After exhausting those internal remedies, aggrieved parties had recourse to the courts.

Mr Cockeran commented that the policy of the legislature should be reflected in the proposed Act itself. Regulations should be used only to implement that policy.

Mr Cockeran said that insurance contracts and futures contracts had a common origin hundreds of years previously. It had to be asked, in such a context, what was the most appropriate way to handle such a risk. The JSE supported the Banking Association's position that the banking sector was the most appropriate to handle the risks under discussion.

Mr Shaun Davies: Director: Surveillance Department, JSE, replied (whether that this Bill was correctly sequenced in relation to the Twin Peaks model) that the JSE's position was that in the Twin Peaks model there would be a separation of the prudential supervision from the oversight of the conduct of the participants in that industry. It was correct that under the present Security Services Act, any financial markets bill that the prudential oversight of financial intermediaries certainly in relation to the securities market fell within the power of the registrar of security services and financial markets. The oversight itself was to a large extent directly performed by some of the SROs. The development of the Twin Peaks model still required considerable input. It would not be appropriate to enact this particular Bill with its current provisions on the oversight of the financial intermediaries by the SROs in the Bill's current state. 

Mr Davies said that to some extent South Africa was catching up with some of the G20 countries, in particular with OTC derivatives. This was not to suggest that South Africa should rush to catch up.

The Chairperson said that this was an involved matter and would have wished to give more time for discussion. The Committee would deliberate further and decide if it needed further engagement. This was not a once-off process.

The meeting was adjourned. 

Written submissions were received from the following:
Maitland Trust
Fitch Ratings
Standard and Poor
Global Credit Ratings Company
Computershare South Africa
Deutsche Bank Global Markets
Grain SA
Norton Rose