Financial Markets Bill [B12-2012]
National Treasury presented, at the Committee's request, a workshop to explain the legislative environment for securities and highlight the Financial Markets Bill's role. Next week it would present revisions based on stakeholder comments. It gave a high level overview of the role of financial markets in the South African economy; the purpose, process, and objectives of the Bill; the policy principles – effective and efficient supervision, financial stability, protection of investors and clients, and other aspects; and technical issues.
The context was the need to secure a safer financial sector to serve South Africa better, with the announcement of a number of changes in approach to regulation. It was important to note the shift to twin peaks. It was important that financial services firms must be held to a higher standard as people’s savings and livelihoods were at risk, as was the entire financial system. National Treasury noted that capital markets converted savings into growth. Savings flowed into financial markets mainly from pensions and life insurance. Due to low domestic savings, there was an increased reliance on foreign savings. Financial markets channelled savings into growth. South African capital markets were particularly deep and liquid. The South African regulatory framework was amongst the best in the world. Key players in the financial, equities and derivatives markets were indicated. The Financial Markets Bill introduced a framework for improving regulation of derivatives. The Johannesburg Stock Exchange (JSE) was vertically and horizontally integrated. JSE subsidiaries and investments were indicated. Strate Ltd was the licensed Central Securities Depository (CSD) for the electronic settlement of financial instruments in South Africa. The Bill updated the Securities Services Act and was tabled after a long process of engagement. The structure of the Bill followed its main objectives. The Securities Services Act and the Financial Markets Bill were compared, and big conceptual issues discussed.
An ANC Member asked if there was really a need for a self-regulatory organisation (SRO) model. Another Member asked what had been the cross-cutting concern about this model globally. What monitoring and evaluation methodology could be applied? How did the model affect South Africa in particular? Was it beneficial to the market or to the users?
A COPE Member asked why was there need to regulate the JSE more. Would the Bill make financial services more affordable or more expensive?
A DA Member asked if one should not move to twin peaks first, before processing the Financial Markets Bill. He asked if the National Treasury's review of the model was still under way and if one should complete it before legislating. The Financial Markets Bill had a broader scope than market conduct. How did these new responsibilities for the Financial Services Board (FSB) fit into the anticipated twin peaks division of responsibility? Under the model proposed in the Bill, would the JSE, which had a commercial function as a listed entity but also had regulatory functions, not have a conflict of interest, as, under the Bill it would regulate itself. He preferred that clearing would be in the law itself, which was subject to the review of the Committee, rather than in the regulations. Clearing was a critical area, in particular in so far as it related to equivalence. South Africa had too small a market to justify its own clearing operation. A new power for the Minister was to approve changes in control. Exactly what did this mean? Did it give the Minister a potential veto over changes in shareholdings? Did this not go a little too far? What would the consequences be if the legislation were to be delayed until after twin peaks.
Credit Rating Services Bill [B8-2012]
National Treasury and the Financial Services Board (FSB) outlined the background to credit rating agencies (CRAs) and ratings, the European Securities and Markets Authority (ESMA) requirements, South Africa's relation to the financial markets, and elements of the Bill. Many of the innovations in the current cycle of legislation related to South Africa's G20 commitments, the need to align to European standards, and to ensure that South Africa's investors were afforded the same level of protection as they would be in the European Union. The FSB explained that credit rating agencies had existed since early 1900s, had initially provided opinion on railway stock in the USA, had evolved into international institutions and were recognised worldwide, and provided an opinion on the issuer’s ability to meet its commitments and, repay debt - this is done via a rating scale. It was with the beginning of the financial crisis that the credit rating agencies began receiving considerable criticism.
FSB explained the rating types in South Africa. Banks, insurance, corporates, public finance ratings, fund managers, and project finance had been stable over the years. However, the troubles for the credit rating agencies began with structured finance, where it was perceived that there was too close a relationship between the issuers and the rating agencies. At the height of the financial crisis, there were up to 85 per cent of these structured finance transactions which had their ratings changed negatively (downgraded). These led to huge losses being incurred in the markets. The crisis was driven by sub-prime mortgage lending. No one yet had the answer as to what exactly went wrong. Clearly the ratings were incorrect. Secondly, human behaviour was involved. Some people concerned with sub-prime lending had clearly committed fraud.
South Africa was a key emerging market for investors and they would require ratings. The international rating agencies already operating in South Africa already complied with the requirements in Europe. What was required and was important was that South Africa had the equivalent regulations, and that those credit rating agencies operating in South Africa were able to show that they were regulated equivalently. South Africa's domestic market was too small to meet the country’s total debt requirements and it would need access to foreign debt capital markets - it would thus need credit ratings - to raise the funding for the requirements for the cost of infrastructure build programmes tabled currently. The role of the credit rating agencies would be driven by investors. These agencies were here to stay and were vital.
The Bill provided for corrective action, with measures to deal with conflicts of interest, enhancing the quality of the credit ratings including publication of ratings, transparency and internal governance, and surveillance of the activities of CRAs. It safeguarded the independence of CRAs. In conclusion the Bill ensured South Africa had regulations in place (an international requirement, from which no escape), and added to credibility of ratings issued in the country. South Africa was part of the European and international regulatory environment undergoing continual update. South Africa's continued access to international markets was vital.
A COPE Member asked why the insurance industry so strongly supported the Bill. Why was it necessary to change the current regime, apart from the need to be in sync with the rest of the world? Why was the insurance industry so concerned if this Bill was not passed.
A DA Member saw equivalence requirements as the only justification of any consequence. He questioned whether the approach taken was appropriate and the potential for conflict of interest between the National Treasury in its roles in issuing debt and introducing legislation to regulate the credit ratings of that debt. Previously National Treasury had replied that it had given the drafting to the FSB. He was still uncomfortable.
The definition of external rating agencies was complicated, and he was impressed by the United States approach of simply appending a list of external structures related to a particular agency. As the credit rating agencies had already submitted, South Africa's proposed legislation opened up the prospect of double regulation and the onerous requirements of the FSB having to endorse every rating coming into the country. From the beginning he had been concerned that the larger credit rating agencies would find it relatively easy to comply with this Bill, but should one not draft a law which made it relatively easy for new entrants to compete? Were we not accepting an uncompetitive space? Had National Treasury read the Parliamentary Legal Adviser's sound legal opinion on the definition of 'this Act'. What would National Treasury say if one did limit that definition? Had it read the legal opinion. The questions around the plain language requirements were well known. It still seemed redundant as credit ratings were written for a technically-minded readership.
ANC Members asked if the Bill took new players into account or if it still 'recycled' the existing credit rating agencies, and questioned the lack of uniformity of the credit rating scales used by the various agencies. How could one have confidence in them? Also credit rating agencies had 'a monopoly of information' and they made a profit out of it. The Acting Chairperson wanted to encourage this process of workshops for the future. He would make sure that next day Members received copies of the response document to be sent by the National Treasury. The Committee would also engage with its legal team to ensure that everything was legally watertight in order to conclude these Bills on time.
National Treasury Financial Markets Bill [B12-2012] Presentation
Purpose and outline
Mr Roy Havemann, National Treasury Acting Chief Director: Financial Markets and Stability, introduced the delegation. The workshop's purpose was for National Treasury to explain the legislative environment for securities and highlight how the Financial Markets Bill fitted in. Next week National Treasury would present revisions to the Bill based on stakeholder comments. He outlined the role of financial markets in the South African economy; the purpose, process, and objectives of the Financial Markets Bill; the policy principles – effective and efficient supervision, financial stability, protection of investors and clients, and other aspects; and technical issues. He commented that this was a higher level overview than previous presentations.
The context was the need to secure a safer financial sector to serve South Africa better, with the announcement of a number of changes in approach to regulation:
- the institutional architecture of regulation: who regulates?
It was important to note the shift to twin peaks.
- strengthening approach to regulation: how do the regulators regulate?
New banking regulations (Basel 2.5 and Basel 3)
▪ Financial Markets Bill
▪ Credit Ratings Services Bill
▪ Financial Services General Laws Amendment Bill (to be tabled in about a month's time)
- strengthening the approach to market conduct: how do firms behave?
▪ Important that financial services firms must be held to a higher standard (people’s savings and livelihoods were at risk, as was the entire financial system) Consumer protection regime needed to be [strengthened].
07 February 2012 Informal briefing on the two Bills
22 May 2012 Formal briefing on Bills
29 May 2012 Public Hearings
04 June 2012 Initial feedback on CRSB
01 August 2012 Parliamentary Workshop
08 August 2012 Final response from Treasury
14/15 August 2012 August Consideration of Bills (Slide 5)
Process going forward
Credit Ratings Services Bill - G-20 requirements
Financial Markets Bill - G-20 requirements (Over the Counter (OTC) derivatives) and update Securities Services Act
Banks Amendment Bill - Basel III and align to new Companies Act (but perhaps tabled early next year)
Financial Services General Laws Amendment Bill - Annual / Bi-annual bill to update various laws, Financial Sector Assessment Programme (FSAP), etc.
Insurance Laws Amendment Bill
Twin peaks Architecture Bill - Establish new market conduct regulator and shift prudential regulation to Reserve Bank (probably towards the end of the twin peaks process)
Twin peaks Amendment Bills - Additional update of legislation
Capital markets convert savings into growth
The central role played by capital markets in South Africa's economy:
▪ To stimulate economic growth, savings must be converted into investment in the real economy
▪ Government and companies access capital through capital markets i.e. issuance of equity, bonds, money market instruments and other - e.g. annual fiscal deficit is financed from bond market
▪ Allow pension funds to invest directly into companies - the Public Investment Corporation (PIC) has large holdings in the Johannesburg Stock Exchange (JSE)
▪ Efficient (liquid and secure) financial market means more efficient allocation of capital, lower cost of capital, risk management, and effective access to domestic and foreign savings. (Slide 7)
He commented that it was very important to have the right framework to regulate those bond markets.
Savings flow into financial markets mainly from pensions and life insurance: Flow of savings from household savings, 1999-2010 (See pie chart, slide 8)
Due to low domestic savings, there was an increased reliance on foreign savings .
Financial markets channel savings into growth (See chart, slide 9)
This was an interesting illustration from the Association for Saving and Investment South Africa (ASISA).
South African capital markets are particularly deep and liquid: equity to debt composition and equity to GDP
(See bar charts, slide 10)
South African regulatory framework is amongst the best in the world : the Global Competitive Index
▪ Strong scores on regulation of securities exchanges, equity market financing, and strength of local equity
▪ Lower scores on ease of access to loans, affordability of financial services and venture capital availability
(See table, slide 11)
Key players in financial markets
1. Providers of market infrastructure , e.g. JSE and Strate [South Africa's Central Securities Depository, owned by the JSE, and by the banks which had an interest in it]
2. Users of market infrastructure - Issuers , Stock brokers (authorised users, participants) , and Investors
▪ Important that all players are appropriately regulated (Slide 12)
The Bill was well arranged in terms of the different players and users of market infrastructure.
Who are the main players in the equities market? (See slide 13)
The equities market was the most important, and the most straightforward.
Financial Markets Bill introduces framework for improving regulation of derivatives
▪ Key lesson of the crisis
▪ G-20 commitment
▪ Two types of derivatives: – “Exchange traded” and “Over-the-counter”
▪ Introduce a regulatory framework for over-the-counter derivatives
– See Treasury discussion document (Slide 14)
Who are main players in derivatives market? (in relation to chapters of Bill) (See slide 15)
The JSE Ltd
▪ The JSE is one of the top 20 exchanges in terms of market capitalisation and the fixed income market is amongst the largest in the world
▪ The JSE is a vertically and horizontally integrated, fully electronic exchange offering issuance, trade and post-trade services (vertical) across five markets – equity, equity derivatives, commodity derivatives, spot and derivative interest rate products, and currency derivatives (horizontal) (Slide 16)
The JSE is vertically and horizontally integrated [makes reference to Strate – see below] (Chart, slide 17)
JSE subsidiaries and investments (See chart, slide 18)
▪ Strate Ltd is the licensed Central Securities Depository (CSD) for the electronic settlement of financial instruments in South Africa
▪ Strate also handles the settlement of transactions concluded on the JSE, including equities and bonds, as well as those executed “off-exchange” and a range of derivative products, and money market securities
▪ Strate’s core function is the clearing and settlement of dematerialised securities [bar chart: equities market – dematerialised value and market capitalisation]
▪ Strate is owned by the JSE Ltd, the four major South African Banks and Citibank, N.A.:
(Slide 19; bar chart, slide 20; and chart, slide 21)
Financial Markets Bill's objectives
The Bill updates the Securities Services Act (SSA)
▪ Repeal & replace Securities Services Act (No 36 of 2004), as amended
▪ Alignment with International developments
– G-20 commitments following global financial crisis
– Financial Stability Board recommendations
– International best practice: International Organisation of Securities Commissioners
– International Monetary Fund (IMF) and World Bank international assessments (Financial Sector Assessment Program (FSAP), and Report on Observance of Standards and Codes)
▪ Changes in principles, laws, e.g. UNIDROIT Convention & international regulatory practices
▪ Technical/functional issues (Slide 23)
Ms Kathy Gibson, Arrowpoint Consultant to National Treasury, noted that what started as a review of the SSA in 2009/10 had escalated beyond that into a substantial review of South Africa's financial markets regulatory environment. This was largely a reflection of the international developments that had taken place subsequent to the crisis of 2007/08.
Tabling of the Bill after a long process of engagement
▪ Securities Services Act Review (2009-11)
▪ Publication of draft Bill on 4 August 2011
▪ Comments Received
▪ Public Forum on 5 October 2011
▪ National Treasury/Financial Services Board (FSB)/self-regulatory organisation (SRO) Working Group reviewed comments
▪ Follow up Treasury-led meetings and correspondence
▪ Consultative workshops with banks and non-bank financial inst.’s
▪ Additional meetings with stakeholders including interdealer brokers (IDBs) and primary dealers (PDs)
▪ Submission of the revised Bill to Parliament
▪ Informal briefing to Parliament earlier this year
▪ Public forum on 9 May 2012 (Slide 24)
National Treasury had spoken extensively to stakeholders, with particular reference to the SROs – by which was meant the market infrastructure which Mr Havemann had spoken about, for example, the JSE and the CSD, as well as the users of that infrastructure (the authorised users, the participants, the issuers and the like). There had been a number of iterations of the Bill. National Treasury had received input and had issued response documents indicating why it had made changes. This was so even before entering into the parliamentary process. Since then National Treasury had continued to engage in public forums and try to address issues of substantive concern. Of course, that did not necessarily mean that National Treasury agreed.
Main objectives of the Bill
▪ Increase confidence in the South African Financial Markets
▪ Promote the protection of regulated persons and clients
▪ Reduce systemic risk
▪ Promote competitiveness of securities services in the Republic (Clause 2: Objects of the Act)
Achieves this through establishing a framework for:
▪ Efficient and effective supervision
▪ Financial stability & mitigating systemic risk
▪ Investor/client protection, taking into account protection against market abuse (Slide 25)
In any financial services regulation, financial stability was key, to ensure that the financial sector delivered according to expectations. The protection of investors was also key. Efficiencies in these market sectors were often driven by the market structure. This was why the structure of the market played an increasingly important role. That related to some of the discussions held around the effectiveness of and the need for an SRO model, to which she would refer later. The way to do this was effective and efficient supervision. It was necessary to mitigate systemic risk, and ensure client protection.
The structure of the Bill follows these objectives
▪ Preliminary provisions
– Definitions, objects of Act (s 1 and 2)
▪ Powers of the Registrar (s 5)
▪ Requirements dealing with the provision of market infrastructure
– Exchange (Chapter III), Central Securities Depository (Chapter IV), clearing house (Chapter V), trade repositories (Chapter VI)
▪ General provisions applicable to SROs (Chapter VII)
▪ Other matters relating to market infrastructure & its users
– Code of conduct, unlisted securities, nominees
▪ Market abuse (Chapter X)
▪ General (Chapter XI)
– Auditing, enforcement
She asked Members to keep in mind the definitions (Clause 1) which explained the terminology necessary for understanding its provisions. She referred Members to the Bill's description of the powers of the Minister and the Registrar. Members would also see the objects of the proposed Act and what the Bill sought to achieve. The Bill worked through the market infrastructure – the JSE, the CSD, the Clearing House, and the trade repositories. There were general provisions which then followed, which applied to all elements of the market infrastructure. It was to be remembered that each of those chapters of the market infrastructure dealt also with the users of that infrastructure. There followed general issues relating to the market infrastructure and its users around codes of conduct and the like. Chapter 10 of the Bill dealt with market abuse. There were some general Clauses at the end dealing with auditing and enforcement.
Securities Services Act (SSA): Financial Markets Bill (FMB) [Comparison]
Mr Havemann pointed out these were quite technical changes. Ms Gibson explained them. (Slides 27-31)
Big conceptual issues
▪ A changing market structure, taking into account the SRO model for regulatory oversight
– Do we have it, do we want it, do we need it?
– Containing market power in an entity that is referee & player
▪ Accommodation of an exchange-lite (SRO lite?)
▪ Expand the scope of regulation – minimise regulatory avoidance/arbitrage
▪ A flexible law for a rapidly evolving, innovating market
▪ Preventing a crisis, containing a crisis, minimising loss – role of the South African Reserve Bank (SARB) as
▪ Keeping market participants honest – curbing market abuse
▪ The interplay of cross-cutting laws – certainty supports stability (Slide 32)
Ms Gibson said that these were the issues that Members needed to understand in order to comprehend all the changes in the Bill. She preferred to talk through the issues as they had emerged for National Treasury, rather than talk about the specifics of the Bill, as the Committee would receive a revised Bill the following week.
There had been a number of issues raised around the SRO model. Under this model the industry regulated itself. This needed to be interpreted in the context of the financial markets as the market infrastructure – the JSE, State and the like – regulating its users, rather than the JSE and Strate merely regulating themselves alone.
There were ongoing debates on what it meant to have an SRO, and whether an SRO model was needed. These debates centred around the fact that these entities issued rules and supervised those rules for their users. These entities also supervised the Act and how those users engaged with each other. Across the world the SRO model was accepted, and there were varying degrees of the implementation of that model.
In South Africa's market, the infrastructure did regulate its users, and it did supervise and issue rules about how those users dealt with each other as well as with the infrastructure. The infrastructure supervised the broader Act, but did not enforce that Act. This would be an important point in SRO discussions going forward.
In terms of why one would want the Act or would need it, there were pros and cons to this model.
The complainants would argue that this Bill gave far to much power to those regulating entities, particularly if those entities made profits rather than were in a mutual structure, which existed in South Africa. On the other hand those entities also understood and knew the market and their users very well; and there were efficiencies, so one could argue that there were benefits to how effective the regulatory oversight was by applying this model.
Whether one needed it was the big question. Mr Havemann had already mentioned the review going forward. This was an important commitment that National Treasury had made. This was not to say that the SRO model would be overthrown overnight. However, National Treasury wanted to test where the SRO model was working or not working, and how perhaps to improve it. The debate, however, was increasingly not just about the SRO model but about what kind of market structure was required, and how much flexibility one could give through the legislation to accommodate different regulatory and operational models. She would talk to that further down the bullet points.
There had also been discussion around an exchange-lite. There had been a concern that, because of the SRO requirements, if one wanted to be an exchange, or a CSD, or a clearing house, it was not only necessary to provide that infrastructure but one also had to have all of these resources to perform the supervisory function associated with being an SRO. This therefore fed into the SRO debate. This meant that there were significant barriers to entry in terms of becoming an exchange, a CSD or the like. Thus an exchange-lite – perhaps one could call it an SRO-lite - had been contemplated. However, National Treasury would never want to think of an exchange-lite, as this would suggest lower requirements for some exchanges than for others. The Bill, on the other hand, would give effect to proportionality – whatever risks one brought into the market, one must be regulated accordingly. So if one brought fewer risks, one would have lighter requirements accordingly in terms of capital, etc.
The SRO-lite was something different. This was contemplating providing the infrastructure but not needing to be a supervisor. National Treasury wanted to introduce the flexibility that separated the operation or the providing of infrastructure from supervising the users. This would form part of that market structure decision or investigation moving forward.
As to expanding the scope of regulation, the biggest lesson learnt was that, out of the crisis, regulation was not complete. If regulation was not complete, entities would increasingly try to move out of one's spotlight into the area where there was a lower level of regulation. It was therefore necessary to ensure that one's regulatory net covered everyone. This was not to say that everybody must be regulated in the same way. However, everybody must be on the radar. Again, that principle of proportionality should accommodate this. This had definitely been captured by this Bill, in so far as it addressed the likes of OTC derivative regulation, for example. However, there were other elements as well. One saw increasing innovation in this market. What had been important was to make sure that whatever started emerging in financial markets, could be named and regulated.
The SSA currently named certain entities, and if an entity was named it was regulated very heavily. If an entity was not named, it might 'fall underneath it' [the SSA] somewhere. However, there was not that power to name the entity as it emerged and regulate it accordingly. In other words, the JSE was named and regulated very heavily. However, there were other exchange-type entities which increasingly were emerging, and there were many new technologies and platforms which enabled this, but were only vaguely defined. In the SSA one was either an exchange or not an exchange. This binary approach was not correct.
A flexible law had been a big shift in National Treasury's thinking. It was necessary to be able to name entities as they emerged. One could talk about contracts for different trading platforms the current legislation could not touch such platforms. However, it was necessary to be able to do so.
Preventing a crisis, containing a crisis and minimising loss were important.
Ms J Tshabalala (ANC) expected a different format – a great many concepts had been presented. She asked if there was really a need for an SRO model.
Mr Havemann noted that the SRO model was one of the main issues raised in the public hearings.
Ms Gibson explained in more detail the SRO model. She also talked about the JSE. The law said that if one was performing this role of trading (matching buyers and sellers in the equities market, for example), one must be licensed as an exchange. By virtue of being licensed as an exchange, one was required by law to perform certain functions. The law described those obligations. The licence also required the exchange to supervise its users. She gave further detail. It also addressed how those users, the stockbrokers, dealt with each other. It was also necessary to monitor compliance of users. However, enforcement was the responsibility of the registrar. The SRO model gave some of that supervisory responsibility to the entity, for example, the JSE. However, it did not remove the ultimate responsibility from the FSB, which was still the regulator. The JSE was not supervising itself: it was supervising its users. The SRO model was working, but it was necessary to test whether South Africa's model of the SRO was best and whether it could be improved, while ensuring that any entity could be exposed and held accountable if it abused its powers in playing its dual role.
Mr N Koornhof (COPE) asked why was there need to regulate the JSE more.
Ms Gibson denied that the Bill intensified the regulation of the JSE. Where the scope of regulation was extended, it was to make sure that where the JSE was interfacing with its users, it was doing so in a fair manner.
The Acting Chairperson asked if these interventions were in response to complaints.
Ms Gibson replied that there was a perception that, because of the JSE's combined role of providing infrastructure to users but also regulating those users, the needs of the users were not always taken as seriously as those of the shareholders. The aim was to make the mechanism more transparent.
Ms Gibson distinguished capital markets from accessing loans through a bank, for example, and investing money not directly in a share but having access to a share through some kind of investment vehicle. This legislation dealt with the shares themselves – how they were listed and traded, and how one owned them directly. It did not deal with investment vehicles and the products which individuals could use to access loans. The existing SSA had also gone a long way to protect investors. This law did protect investors and introduced additional protection.
Mr Havemann pointed out that this Bill was more a prudential bill rather than a market conduct bill, and dealt more with how the system functioned.
Dr Z Luyenge (ANC) asked what had been the cross-cutting concern about this SRO model globally. What monitoring and evaluation methodology could be applied? How did the SRO model affect South Africa in particular? Was it beneficial to the market or to the users?
Ms Gibson replied that the international experience was similar to South Africa's. In the event that one had an SRO that was for profit, conflicts of interest did emerge. In the international arena there were principles to manage these conflicts but they were very high level. For purposes of legislation, it was necessary to give practical effect to those principles. From a stability perspective the model had been effective. It was reliable. However, the users of the infrastructure needed to be given more of a voice as to making sure that the services were provided in an efficient way.
Mr Koornhof asked if the Bill would make financial services more affordable or more expensive.
Ms Gibson replied that the Bill provided for disclosure of the way in which fees were calculated and for greater accountability in the pricing. So financial services need not be more expensive. However, for those areas of the market that had not previously been subject to supervision, it might be expected that the cost would increase.
Mr Havemann added that it was important to balance any additional costs resulting from increased regulation with the potential costs of not regulating.
The Acting Chairperson could not agree more.
Mr T Harris (DA) understood that National Treasury was interested in transitioning to a twin peaks model. He asked if one should not move to twin peaks all at once or firstly, before processing the Financial Markets Bill.
A related question spoke to the SRO model and Treasury's commitment to review it. Was that review still under way and should one not complete it before legislating?
Under the twin peaks model, the FSB was meant to do market conduct. However, the Financial Markets Bill had a broader scope than market conduct. How did these new responsibilities for the FSB fit into the anticipated twin peaks division of responsibility?
Under the model proposed in the Financial Markets Bill, would not the JSE, which had a commercial function
as a listed entity itself but also regulatory functions, have a conflict of interest, as, under the Bill it would regulate itself.
He had a problem with the idea that clearing would be in the regulations rather than in the legislation itself. He preferred that clearing would be in the law itself, which was subject to the review of the Committee. Clearing was a critical area, in particular in so far as it related to equivalence. South Africa had too small a market to justify its own clearing operation.
A new power for the Minister was to approve changes in control. Exactly what did this mean? Did it give the Minister a potential veto over changes in shareholdings? Did this not go a little too far? He heard alarm bells.
Mr Havemann replied that National Treasury had thought quite hard about the twin peaks process The Financial Markets Bill dealt specifically with G20 requirements that South Africa was required to fulfil this year and before next year. Many of the provisions of this Bill were urgent. Also, as Ms Gibson had indicated, this was the end of a three year review of the Securities Services Act, and there were many changes which responded to this review. National Treasury had considered delaying this Bill until twin peaks, and there would have been advantages and disadvantages in doing so. The advantages would have been doing everything together. The disadvantage would be that a huge bill. So National Treasury had decided to stagger it over the course of two or three years. The Twin Peaks Architecture Bill – to establish the two regulators and shift prudential regulation to the South African Reserve Bank - would probably come before the Committee early in 2013. National Treasury had spent considerable time studying the Australian experience of twin peaks. Australian insurance law was very interesting as responsibility for regulation was divided up amongst various regulators. This was an elegant way. It meant that all Australian insurance legislation was in one place. He did not think that twin peaks would create a brand new Financial Markets Bill. Rather it would create a few simple changes, but one could not do that until establishment of the twin peaks.
Mr Havemann explained that Mr Jonathan Katz, Advisor: World Bank, who used to be secretary of the Securities and Exchange Commission in the United States, would be beginning the process of consultation with all the stakeholders on the SRO model.
In terms of the FSB's market conduct role, this was a combination of systemic requirements and regulation, prudential and market requirements, all laid out together. When the FSB was transformed into a market conduct regulator, it would assume responsibilities for the market conduct components of securities regulation.
Next week National Treasury would explain new safeguards on JSE regulatory functions and conflict of interest.
There was an extensive chapter on clearing requirements. The legislation established the clearing house. The functions of the clearing house were a subject more appropriate for the regulations as it was a dynamic area of work. One needed flexibility on certain issues.
Ms Gibson added that this Bill responded to what was regulated and how. It did so in response to the developments in recent years, as well as the experiences of the FSB and where it was felt that it was imperative to tighten up on the existing law. Who regulated was an overlay to what was regulated and how. However, one did not want to hold up the whole Bill on the subject of who regulated.
Ms Gibson said that the changes in control referred to the market infrastructure, which captured market repositories, rather than SROs, which did not. The market infrastructure comprised entities of systemic and national importance. Therefore this approval was seen as necessary in order to give protection to the policy framework related to the market structure of the financial markets. This was not unprecedented.
Mr Havemann said that who had a controlling interest in the JSE, which was listed on its own exchange, was a very important question for National Treasury in terms of securities regulation. This must be addressed in the context of broader policy objectives.
Mr Harris asked what the consequences would be if the legislation were to be delayed until after twin peaks.
Mr Havemann replied that a serious consequence would be that South African banks would face a greatly uncertain environment for OTC derivatives trading.
Moreover, South Africa would be thrown off course in its G20 commitments. An extreme consequence might be that the European Union would “free-out” South Africa – the approach it had taken with credit ratings. A less extreme consequence would be that South Africa would not have the same rules as the other 18 players. It was necessary to distinguish global priorities from domestic ones. The Financial Markets Bill dealt specifically with global priorities. Twin peaks was a domestic priority and would follow its own course.
For practical purposes, National Treasury did not want to delay five or six complex pieces of legislation only for twin peaks as this would be onerous on the Treasury and on the Committee.
National Treasury Credit Ratings Services Bill 2012: Workshop
Mr Havemann noted that his co-presenter, Mr Roland Cooper, FSB Board Senior Specialist: Credit Ratings, was formerly with Fitch, one of the big three credit rating agencies, and would be looking after the regulation of credit rating agencies for the FSB. He outlined the agenda:
▪ Background to credit rating agencies CRAs and ratings
▪ European Securities and Markets Authority requirements
▪ South Africa and financial markets
▪ Elements of the Bill
He observed that many of the things being introduced in the current cycle of legislation related to South Africa's G20 commitments, the need to align to European standards, and to ensure that South Africa's investors were afforded the same level of protection as they would be in the European Union. Not only this, but also to ensure that South Africa could engage with the European Union in an appropriate way. It was very interesting to observe what had been happening in the world of financial regulation, particularly in the last year or two. When first attending G20 meetings on financial regulation just after the crisis, there was a feeling that all the countries were in this together and would produce a coordinated response globally to everything. Unfortunately, what had crept into the financial regulatory space was that countries were introducing requirements and to some extent requiring that all the other countries met their requirements. This was particularly so with the United States and the European Union, and in many respects South Africa was responding to their requirements, to ensure that its capital markets were regulated in the same way as theirs. This was quite good from the perspective of ensuring a globally coordinated response to the financial crisis. However, it necessitated new regulations and requirements in South Africa. Mr Cooper would talk about the South African financial markets and the elements of the bill, and then the conclusion.
Mr Cooper explained:
▪ Credit rating agencies have been around since early 1900’s
▪ Initially provided opinion on railroad stock in USA
▪ Have evolved into international institutions, recognised worldwide
▪ Provide an opinion on “Issuer’s ability to meet its commitments, repay debt”
– This is done via a rating scale. (Slide 3)
He observed that it was with the beginning of the financial crisis that the credit rating agencies began receiving considerable criticism. Statistics could be provided to the Committee, if required. Essentially these agencies provided an opinion, and they claimed and insisted that it was an opinion only, on an issuer's ability to meet its commitments to repay its debt. This was done by a ratings scale. Such scales were not standardised across the industry. It was up to the investors and users of those scales to understand them.
Rating Types in South Africa
▪ Public Finance
▪ Fund Managers
▪ Project Finance
▪ Structured Finance (Slide 4)
By invitation the credit rating agency would enter and rate the sovereign first. Secondly it would rate the banking industry, before anything else. Banks, insurance, corporates, public finance ratings, fund managers, and project finance had been stable over the years. There had not been any criticism of those. However, the troubles for the credit rating agencies began with structured finance, where it was perceived that there was too close a relationship between the issuers and the rating agencies. In many instances the rating agencies had been accused of toeing the line for the issuers and the people who had paid for the ratings. At the height of the financial crisis, there were up to 85 per cent of these structured finance transactions which had their ratings changed negatively (downgraded). These led to huge losses being incurred in the markets. These losses to date ran into trillions of dollars. The methodology in the structured finance arena had to be revisited. It was necessary to remember that the crisis was driven by sub-prime mortgage lending. This was distinct from prime rate lending. Credit-worthy wise the people who had taken out these sub-prime mortgages were sub-prime: they were not able to raise finance through normal channels, and neither did they qualify through normal credit channels. So this sub-prime mortgage arena had sprung up. From the mortgage houses which had additionally dealt with them – and they were not the banks - they transformed individual mortgage loans into mortgage bonds, which entered the market and were purchased by banks and other investors who had relied on the ratings assigned to them. It was a massive market which grew exponentially over time. In that time the credit rating agencies were on a learning curve. One was coping adequately with the ratings that they were providing until things went wrong. No one yet had the answer as to what exactly went wrong. Clearly the ratings were incorrect. Secondly, there was human behaviour involved. Some people concerned with sub-prime lending had clearly committed fraud.
South Africa and Ratings
▪ South Africa a key emerging market for investors and they will require ratings
▪ Need multiple sources of funding for the Banks, Corporates, etc., Foreign sources are vital
▪ Expect to see more ratings (Slide 5)
He said that in South Africa in the structured finance market there had been none of those disasters. This particular market had been well-managed and well-treated. It also went beyond just the regulation of credit rating agencies. It extended into the regulation of the central bank as to how it saw the need to regulate and manage securisations. The market itself was so much smaller, and manageable by the local banks as compared with the international banks.
He posed the question as to why one needed these credit rating agencies. It was not simply a case of saying that somebody had to do it. He thought that they had a vested interest in what they did, a massive infrastructure set-up, a massive research operation, and they were able to make a comparison of a country against its peer groups, or a business or an institution against its peer groups worldwide. One of the 'nice' things about an international rating was that it was valid worldwide.
South Africa needed multiple sources of funding for banks and the corporates, and here the foreign sources of finance were going to be important. Those foreign investors who provided funds would drive the process, and in that process, one could expect to see many more ratings being produced.
As opposed to discouraging people from using these ratings, in the emerging markets space it could be expected that investors would use credit rating agencies and other institutions to provide opinions to them.
One of the big drivers of this regulation, and it was a requirement in Europe, was that South African credit rating agencies providing ratings into Europe must have an equivalent regulatory regime.
European Securities and Markets Authority (ESMA)
▪ Global nature of credit ratings
▪ Cross-border activities of certain CRAs
▪ Importance of on-going supervisory and enforcement-related cooperation
▪ Require a memorandum of understanding (MoU) which sets forth the Authorities’ intent to cooperate with each other. (Slide 6)
He said that the requirement was to bring everybody into the net in order to make these credit ratings valid in the eyes of the authorities.
CRAs were not strictly domiciled to the territories in which they rated. It was recognised that their expertise lay in individual countries and they utilised those skills across borders.
One of the requirements of this regulatory environment was that South Africa provided the ability, for example, to regulate on behalf of Europe.
The Authorities will, within the framework of this MoU:
▪ Provide each other with the fullest cooperation permissible
▪ Supervise cross-border CRAs, and
▪ Enforce compliance with the relevant Laws and Regulations
▪ Authority will accordingly notify the other Authority about the status of the CRA’s recognition, authorisation, or registration; and
▪ Will provide it with the information regarding the CRA’s cross border operations
Authorities agree that they will cooperate with each other:
▪ in discharging their on-going supervisory responsibilities in respect of Cross Border CRAs
▪ inform each other immediately when an enforcement or supervisory action has been taken against a Cross Border CRA
The assistance includes, but is not limited to:
▪ providing information and documents held
▪ obtaining information and documents
▪ taking or compelling a person’s statement, or testimony under oath
▪ conducting on-site inspections to gather information (Slides 7-9)
He said that this appeared negative and aggressive. However, the international rating agencies already operating in South Africa already complied with these requirements in Europe. What was required and was important was that South Africa had the equivalent regulations, and that those credit rating agencies operating in South Africa were able to show that they were regulated equivalently.
Credit ratings issued in South Africa are recognised in Europe
▪ South Africa continues to have access to regulated international capital markets
▪ South Africa maintains international position, International Organisation of Securities Commissions (IOSCO)
He said that the result was positive. Credit ratings issued in South Africa were recognised not only in Europe, but continued to be recognised worldwide. Many of these requirements were driven by G20 through IOSCO, and into other organisations like ESMA.
South Africa - Domestic Market
▪ Active, sophisticated and world class local Debt Capital Market
▪ R trillions of funds under management
▪ Will continue to require the role of international and local credit rating agencies
▪ Market has the choice to rely/not rely on credit ratings issued (Slide 11)
He said that South Africa was an A-field player. These funds under management were those of people who had saved and invested largely to make provision for retirement. In that role up until now, local and international credit rating agencies had provided ratings if they were required for regulatory and other purposes. This market would continue to require the role of these rating agencies. This was because of the need to encourage competition and extend the markets to new players. If someone wanted to start a new fund management operation, it would be very expensive to build up the credit and risk teams required. As an alternative, such an operation could chose to rely on the ratings issued by the credit ratings agencies. 21M 49s of part 2. Whilst worldwide people deplored the reliance on credit ratings issued by the agencies, the local market in South Africa could chose to rely on them. After all, they had the world expertise at their finger tips. And if anyone chose that, there should be equivalent regulations to put South Africa on the A-field in terms of how the country managed this.
SA - International Debt Raising
▪ Domestic market is too small to meet Country’s total debt requirements,
▪ Would “mop up” and take liquidity out of the local market
▪ Need access to foreign debt capital markets
▪ Will need a credit rating, probably two, maybe even three ratings
▪ Others to follow (Slides 12-13)
He said that on the international debt raising South Africa was going to be very strong in the years going forward. It would be important for the country, and certain institutions in the country, to raise the funding for the requirements for the cost of infrastructure build programmes tabled currently. The domestic market was too small. It was just not possible to raise the funding locally. The role of the credit rating agencies would be driven by investors. These agencies were here to stay and were vital.
The Bill contained measures to deal with:
▪ Conflicts of interest
▪ Enhancing the quality of the credit ratings, including publication of ratings
▪ Transparency and internal governance
▪ Surveillance of the activities of CRAs (Slide 14)
Independence of CRAs
“20. No person, including the registrar, may hinder, interfere with, obstruct or improperly attempt to influence a credit rating, the content of a credit rating, or any methodology, model or key assumption used by a registered credit rating agency to derive a credit rating.” (Slide 15)
He emphasised the above, and that it would be business as usual for the CRAs, who were welcome, however, to improve their methodologies. One of the measures not adopted or even suggested was a need to approve the methodology changes as made by the credit rating agencies. This was not considered possible at the moment. The independence of the CRAs was thus enhanced.
▪ The Bill ensures South Africa has regulations in place (an international requirement, from which no escape).
▪ The Bill adds to credibility of ratings issued in the country.
▪ South Africa is part of European and International regulatory environment, undergoing continuous update.
▪ South Africa – access to international markets.
He noted that the Europeans were now on the third draft of their implementation, and were racing ahead. Also South Africa's continued access to international markets was vital. (Slide 16)
Mr Koornhof knew that the insurance industry strongly supported the Bill. Why did this sector particularly favour this proposed legislation? He asked for examples. He acknowledged the need for regulation, and understood what Mr Havemann and Mr Cooper had dealt with here. He was sure that South Africa would complete its legislation before the European Union completed its third draft. However, why was it necessary to change the current regime, apart from the reasons given, and the need to be in sync with the rest of the world? Why was the insurance industry so concerned if this Bill was not passed.
Mr Koornhof could easily have asked ten questions, but because of the time constraint would ask them later at the Committee level.
Mr Harris saw the only justification of any consequence as the equivalence requirements, but he questioned whether the approach taken was appropriate.
He asked once more about the potential for conflict of interest between the National Treasury in its role in issuing debt and National Treasury in its role of drafting legislation to regulate the credit ratings of that debt. Previously National Treasury had replied that it had given the drafting to the FSB. He sought clarity of that explanation as he was still uncomfortable with it.
The definition of external rating agencies was complicated, and he was impressed by the United States approach of simply appending a list of external structures related to a particular agency. As the credit rating agencies had already submitted, South Africa's proposed legislation opened up the prospect of double regulation and the onerous requirements of the FSB's having to endorse every rating coming into the country.
From the beginning he had been concerned that the larger credit rating agencies would find it relatively easy to comply with this Bill, but he was not sure that one should be comfortable with that number of rating agencies. Should one not draft a law which made it relatively easy for new entrants to compete. Did this Bill achieve that? Were we not accepting an uncompetitive space?
The Parliamentary Legal Adviser [Adv Frank Jenkins] had given a sound legal opinion on the definition of 'this Act'. What would National Treasury say if one did limit that definition? Had it read the legal opinion.
The liability in this Bill went much further than in other bills and other models around the world where a breach was criminalised. Surely this was far too harsh a sanction? Could we not limit it to wrongful intent, gross negligence or fraud? One was dealing with a free market in which issuers paid for the ratings and were free to chose another rating agency. Was criminalisation not too harsh?
The questions around the plain language requirements were well known. It still seemed redundant as credit ratings were written for a technically-minded readership.
As to the comment about the European Union racing ahead, he was not sure if that was intended to focus the Committee's mind on expediting the Bill. However, it was appropriate that the European Union did race ahead, as South Africa was a very small market and needed to make sure that whatever legislation it adopted it was clear about what the larger markets had done first. What was the motivation for that statement?
The Acting Chairperson said that Mr Harris, speaking of criminalisation, had reminded him of a country where defrauding and corruption were punishable by death.
Mr E Mthethwa (ANC) asked if the Bill took new players into account, or if it still 'recycled' the existing credit rating agencies.
The Acting Chairperson noted that Mr Mthethwa was commenting on whether the Bill was open or otherwise to the prospect of encouraging new entrants to the market. This was a loaded question as he knew the agencies and it was a tight market. The requirements were 'just too high'.
The Acting Chairperson agreed.
Mr Cooper replied to Mr Koornhof that it was necessary to change the present regime as it was 'broken'. If South Africa wanted to play in international markets it had to accept their requirements which required that South Africa had regulations in place. The equivalence requirements were the biggest driver of the Bill. The credit rating agencies were explicitly exempt from any liability or responsibility, and answered to no one, only to themselves. He spoke from his previous experience in a credit rating agency – Fitch. There was indeed a requirement for regulations and for fairness in the treatment of credit rating agencies. His colleagues had discussed at length. Indeed, credit rating agencies offered an opinion, but this opinion was relied upon. Where they had been wrong, the credit rating agencies' opinions had caused major losses. Moreover, these opinions were paid for. The requirement for regulation was a worldwide phenomenon and was probably overdue. It was clarifying the rules rather than being vindictive against the credit rating agencies. It might be asked if the Bill was not a response from Government because of the negative reviews that it had been receiving from the credit rating agencies. This was not the case. 'Not at all – it was an international requirement'.
Mr Havemann replied to Mr Harris that National Treasury had not tried to impose its will in the drafting of the Bill, and had been very mindful of the potential for conflict. It was a very important question. Mr Cooper had referred to Clause 20 and that was a very important principle contained in the Bill. National Treasury had made every effort to avoid conflicts of interest. There was a procedural requirement that only the Minister of Finance could introduce a financial bill into Parliament.
Many of the definitions were probably to be dealt with better in National Treasury's response next week, in which response it had taken on board many of these issues. However, he indicated that National Treasury had detected from many of the commentators that there was a misunderstanding of the role of external credit rating agencies. Two sets of comments had emerged: on the one hand, the insurance industry was excited by the Bill. Also, because issuers paid for the ratings, the perception was that issuers could change the credit rating agency if they did not like it. It was important to highlight this. It did not say that the people who used the credit rating, such as the investors, the insurance companies and the pension companies, had very little control over the issuance of opinions and the choice of credit rating agency. One of the commentators had suggested that one should allow the users of the credit ratings more power in the choice of which credit rating agency was chosen. This was quite a good proposal, but not workable in the context of the European Union requirements. However, the 'issuer pays model' created many problems, in so far as that it was the issuer of debt who paid for the rating, not the user of the rating. This led to much of the necessity for tight regulation, because the actual market could not punish credit rating agencies that did not do it appropriately. It was interesting that, when the United States was downgraded from a triple A rating, bond yields, a market measure of an issuer's ability to repay, actually improved, suggesting that the market did not take the credit rating agencies as seriously as they should be taken.
Mr Cooper added that one of the big arguments had always been that the issuer paid, therefore there could be a conflict of interest. There was an alternative model, in which the investor paid; however, this model should be addressed by the market more than by the regulator. This model had often been suggested to investors, but they could give a number of reasons why not.
Mr Havemann acknowledged the confusion over the definition of external credit rating agency. Therefore the wording had been tightened up, and would be brought to the Committee next week. This also applied to the endorsement criteria. Here the intention had been misread, and it had now been made clear.
Some of the commentators from the smaller credit rating agencies had actually welcomed the Bill, because the two smaller agencies in South Africa had no way of proving to the market that they had appropriate methodologies and tools. There were five credit rating agencies in South Africa, but only the big three were well-known.
Mr Cooper added that one of the Bill's Clauses actually stated that registrar could give exemption from registration. This could encourage a start-up credit rating agency to enter the market. However, he did not think that the start-up agencies in South Africa would become big internationally. To become an international player was a massive undertaking. Hence the regulation requirement for someone who held a dominant position in the market.
Mr Havemann found most useful the Parliamentary Legal Adviser's legal opinion on the definition of 'this Act', and had engaged with the Adviser extensively. In the new draft the definition was slightly narrower. There was, however, some inconsistency in the definitions across the various pieces of financial services legislation, so one was working towards aligning all the definitions.
The Bill's latest version took away liability (in terms of criminalisation). So there was certainly no criminalisation of liability. There had been a misunderstanding.
The plain language requirement was very important. There had been many comments and he would respond in more detail next week. However, it was important that as far as possible the people who were using the ratings understood them. It was very easy for credit rating agencies to write opinions in 'financial markets babel'. Hence the need for a plain language requirement, and this was internationally consistent.
Mr Cooper said that one was mindful of what the European Union was doing. Its bill was adopted in 2010. The first revision was to change it from the European Authority to the Established Authority, which was ESMA. Then came CRA2 on which feedback was received. Then followed CRA3 which proposed the rotation of analysts, and quite an onerous liability clause. The European Union was determined to continue regulating and tighten up. The requirement for a period of notice of a sovereign downgrade, or any change in a sovereign rating, had been introduced. South Africa would be able to adopt, in terms of equivalence, under the European Union's current legislation. However, for the future, South Africa might have to be prepared to make amendments to remain equivalent. However, currently he was confident that South Africa could comply, on the basis of a questionnaire completed for ESMA.
Mr Havemann thought that Mr Mthethwa's 'new players' question had been answered already as part of the response to another question. There was always a balance to be sought between regulation and allowing the new players to enter. The Banks Act had an onerous requirement to allow an entity even to call itself a bank, and this was how it should be.
The Acting Chairperson asked if there were any further responses from the delegation.
Ms Jeannine Bednar-Giyose, National Treasury Director: Fiscal and Intergovernmental Legislation, replied that National Treasury would be proposing, next week, some revisions of the definition of 'this Act', in line with consultations with the Parliamentary Legal Advisers. She believed that this proposal would be an acceptable amendment.
In response to Mr Harris's query about the criminalisation of offences, National Treasury would propose some slight tightening of the wording in the offences and penalties provision, which, she felt, would address some of the concern of commentators.
The Acting Chairperson asked if National Treasury's responses to public comments could be provided to the Committee ahead of next week's session, to enable it to prepare.
Mr Havemann said that the National Treasury responses on both Bills were complete and could be sent to the Committee the next day.
Ms J Tshabalala (ANC) questioned the lack of uniformity of the credit rating scales used by the various agencies. How could one have confidence in them? Also credit rating agencies had 'a monopoly of information' and they made a profit out of it.
Mr Cooper replied that the credit rating agencies would be loath to say that they had an established methodology that was industry wide. They set their own methodologies and criteria, which were very similar and available on the agencies' websites to the general public. Largely the investor community took the criteria and the methodology and ran models themselves while making comparisons. It was well-known, especially in the structured finance industry, that certain methodologies gave better ratings than others. In the international market one was required to open a portal on which all information must be made available. Any credit rating agency could access it and comment. At the moment this requirement did not exist in South Africa. However, there was discretion. Also if a credit rating agency lacked information and felt that it could not provide information, then it must not provide a rating. However, these methodologies would differ in small respects. The agencies were required to review their criteria and methodologies at least annually, and publish notification of changes or lack of change. The general feeling worldwide and in South Africa was that reliance on credit ratings was to be discouraged. Conversely, however, one might encourage reliance on them – this the investors would determine themselves: the regulatory authority would not determine it. There had been big improvement in the publication of information. This fell under the general heading of integrity of the ratings. It distinguished between solicited and unsolicited ratings.
The Acting Chairperson wanted to encourage this process of workshops for the future. He would make sure that next day Members received copies of the response document to be sent by the National Treasury. The Committee would also engage with its legal team to ensure that everything was legally watertight in order to conclude on these Bills on time.
The meeting was adjourned.
- PC Finance: Workshop hosted by National Treasury on the Financial Markets and Credit Ratings Services Bill-part1
- PC Finance: National Treasury on the Financial Markets and Credit Ratings Services Bill-part1
- PC Finance: Workshop hosted by National Treasury on the Financial Markets and Credit Ratings Services Bill-part1
- PC Finance: National Treasury on the Financial Markets and Credit Ratings Services Bill-part1
- Annexure C: An Examination of the South African OTC Derivatives Markets to Recommend Measures for Strengthening their Regulatory
- Annexure B: Reducing the Risks of Over-the-counter Derivatives in South Africa
- Financial Markets Bill [B12-2012]
- Credit Ratings Services Bill [B8-2012]
- National Treasury Financial Markets Bill 2012 Presentation
- National Treasury Credit Ratings Services Bill 2012 Workshop
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