Financial Sector Assessment Programme: National Treasury & International Monetary Fund briefings

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Finance Standing Committee

05 August 2015
Chairperson: Mr Y Carrim (ANC)
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Meeting Summary

The National Treasury gave a contextual background to the Financial Sector Assessment Programme (FSAP) of South Africa, which was undertaken in 2014. This was supported by a presentation by a representative of the International Monetary Fund, who explained what the FSAP was. Following the 2008 global financial crisis, South Africa, with the other G20 countries, undertook to make the financial sector safer through reforms that would be achieved by strengthening international standards and using peer reviews, and the FSAP was conceptualised as a five yearly, comprehensive and in depth analysis of a country’s financial sector. It comprised assessment, reports and technical notes. It was noted that the biggest South African banks operated in Africa and the UK, where they were supervised by host regulators in those countries. The peer review would allow both investors and regulators to place reliance and trust in a country’s financial sector, and it was backed up with significant fines to persuade compliance.

The IMF presentation described some recent FSAP assessments around the world, noted that these were looking to the resilience of the financial sector, the quality of the regulatory framework, the capacity of the sector to withstand shocks, and developmental aspects. The FSP assessment had found that the South African sector was large, sophisticated, highly concentrated and interconnected with relatively high capital reserve buffers and had sound regulation and supervision in place. It had elevated, but manageable, financial sector risks. Recommendations were made for heightened scrutiny of asset quality and liquidity risks, strong regulation and supervision to ensure financial sector resilience. More details of the FSAP recommendations were set out, including Twin Peaks, macro and micro prudential regulations, financial safety nets, Over The Counter derivative reforms and competition and market structures. The presentation then looked at the Detailed Assessment Reports (DARs) on banking, on insurance and on securities. It moved on to look at a Technical Note on anti - money laundering and the combating of financial terrorism. The presentation then looked at how South Africa was responding to the FSAP, the regulatory architecture before FSAP, Twin Peaks as being part of a comprehensive system and an opportunity for better regulation and at how FSAP policy responses would be phased in.

Members asked what the IMF’s take on Twin Peaks was. Was South Africa’s liquidity a major risk factor? Were there developments South Africa should be concerned about? Members requested additional information and reports. Members asked how much regulation South Africa had to ensure so that fines like that incurred by Standard Bank did not occur.

Members said FSAPs had been done around the world and asked how beneficial they had proven to be. Members asked for clarification on what shocks to the financial system the presenters were talking about. Members questioned whether there had in fact been a financial crisis. What did the term ‘strong regulations’ mean. Members what risks needed to be regulated and were the regulations meant for high or low probability issues?

Members asked whether the level of concentration in the financial sector was unusual when compared to the rest of the world, asked about any similarities or inconsistencies between home and host regulators, and wondered if there were risk factors in South Africa's liquidity. They asked how much regulation was in place, and what would ensure stability, wondered how beneficial FSAPs done elsewhere had been and what particular shocks to financial systems were being spoken of. They wanted to have more detail on the current standing, to what extent monopolies in banks were a problem, whether the financial sector regulations would try to reduce monopolies over time, experiences elsewhere. Members wanted to have a clear indication of he relationship between Twin Peaks and the other Bills, and wondered if South Africa was ready to move to that arrangement. Noting that other departments and regulators were involved, Members asked if there were programmes to build up capacity of other law enforcement agencies, and if any risk assessment was done on risks associated with expanding into the continent. The DA commented that it did not see the Twin Peaks legislation as a particular priority, but the Chairperson said that there was nothing to stop the Committee looking at the issues before getting the bill formally tabled. 

Meeting report

Financial Sector Assessment Programme (FSAP): National Treasury briefing

Mr Ismail Momoniat, Deputy Director General: Tax and Financial Sector Policy, National Treasury (Department of Finance) gave a brief background context to the Financial Sector Assessment Programme (FSAP). He said that following the 2008 global financial crisis, South Africa, with the other G20 countries, undertook to make the financial sector safer through reforms that would be achieved by strengthening international standards and using peer reviews. The FSAP was a five yearly comprehensive and in depth analysis of a country’s financial sector. The FSAP is comprised of the Financial System Stability Assessment (FSSA), the Detailed Assessment Reports (DARs) and Technical Notes.

He said the biggest South African banks operated in Africa and in the UK and were thus supervised by host regulators in those countries, apart from being supervised by a home regulator in South Africa (SA). Two major South African financial institutions, Barclays (ABSA) and Old Mutual, had their primary listing in England, which meant that in South Africa they were governed by a host regulator, while being subject to a home regulator in England.

He said the peer review allowed investors and regulators to place reliance and trust in a country’s financial sector. There were risks of significant fines by overseas regulators, and twenty of the world’s biggest banks had paid R235b in fines in the past seven years. Standard Bank of South Africa had incurred a fine of £7m in England, and the question was whether this occurred because of weaknesses within the South African regulatory landscape.

International Monetary Fund briefing

Mr Axel Schimmelpfennig, Senior Resident Representative, International Monetary Fund (IMF), in South Africa, then spoke to the FSAP assessment of South Africa, noting that the health of a country’s financial sector had far-reaching implications for its own economy and other economies. He described some recent FSAP country assessments around the world. He said the FSAP looked at the resilience of the financial sector, the quality of the regulatory framework and the capacity of the sector to withstand shocks. Apart from looking to the stability of the financial sector, it tried to assess the developmental aspect of the sector. Three quarters of the IMF member countries had completed assessments.

One of the 2014 FSAP findings was that the SA financial sector was large, sophisticated, highly concentrated and interconnected with relatively high capital reserve buffers and had sound regulation and supervision in place. It had elevated, but manageable, financial sector risks. The findings recommended heightened scrutiny of asset quality and liquidity risks and noted that strong regulation and supervision were essential to ensure financial sector resilience, especially when the economy was going through a period of slow growth.

He did not speak to the rest of his presentation, in the interests of time, (see attached document for full details) and referred members to the IMF website for more information.

Discussion

Ms M Khoza (ANC) asked what the IMF’s take on Twin Peaks was. She wondered if South Africa’s liquidity was a major risk factor, and asked if there were developments South Africa should be concerned about.

Ms S Nkomo (IFP) requested additional information and reports, such as the G20 peer review report. She asked how much regulation South Africa had to ensure stability, so that fines like that incurred by Standard Bank did not occur again.

Mr A Lees (DA) said FSAPs had been done around the world, and asked how beneficial they had proven to be. He asked for clarification on what "shocks" to the financial system the presenters were talking about. He asked whether what had been described as " the global financial crisis", he asked whether it had in fact been a financial crisis. Finally, he wanted to know what the term ‘strong regulations’ meant.

The Chairperson asked whether the level of concentration in the financial sector was unusual when compared to the rest of the world. He asked what happened if there were inconsistencies between the home and host regulators.

Mr Momoniat replied that the IMF believed in “intrusive, intensive and effective actions” being taken rather than keeping a light hand on the rudder.

With regards to home and host regulators, he said that while there may be a home regulator, South African companies also operated in other countries, so the ethic was to do unto all other companies in the world in the same way as South Africa would like to see other countries treating its own companies.

The Chairperson asked if, when the global financial crisis occurred, there was a sense that SA handled it better because of the strength of the banking sector. He also asked for comment on SA’s standing currently.

Mr Schimmelpfennig replied that the IMF’s concern was mainly the low growth rate, the high unemployment rate and income inequality. SA had a high reliance on external funds, which was highly volatile money. He said while the benefits could not be measured, the cost of going through a banking crisis was that it led to negative growth for many years afterwards, and therefore a strong regulatory framework was necessary to avoid such scenarios.

He clarified that the "shocks" to the financial system were stress tests where capital requirements and cash liquidity requirements were simulated on a system, to see what effects these would have on banks and institutions.

He said that SA was at the forefront of regulatory reforms, being the first to fully adopt Basel III.

He noted the high levels of concentration in South Africa meant that if one institution was affected it would have an impact on the others.

Mr Momoniat said stress tests were done as a routine and were now part of the way people operated.

The Chairperson noted that it might be said that monopolies in banks were a problem, and therefore asked whether the financial sector regulation would have, as one of its aims, reducing the extent of monopolies over time. He wondered also if there were other countries similar to South Africa in this regard?

Mr Momoniat replied that Sweden and Australia were similar.

Ms Khoza felt that SA was different to Sweden and Australia because the majority of people were excluded from ownership. She wanted to know if the IMF considered this as a major risk factor to stability?

Mr Momoniat said that, to the extent to which SA had banking monopolies, the question was then whether barriers to entry were too high or too low. On the other hand, the insurance industry was also concentrated so a small problem in that industry posed a bigger risk. In his view, it would take a very long time, if it was possible at all, to move away from the current set up. The cross linkages between banks and insurers posed risks.

Mr Lees wanted to know, quite apart from the 2008 crisis, what risks needed to be regulated and if the regulations were meant for high or low probability issues.

Mr Rene Van Wyk, Registrar of Banks, replied that one had to understand the depositors of a bank as they controlled the funding of the bank. Banks offered mortgages - and the answer to the question - Was this a technical risk? - was clearly yes, but the probability of the risk was low.

In relation to the concentration of banks, he said that even where there were smaller banks, citizens would generally still put their money into big banks as it would be regarded as more secure.

SA banks had the highest compliance with Basel III core principles. SA was the twelfth country assessed and the first to be compliant with all its principles. The reason why SA had not been as badly affected by the crisis in 2008 was because SA was not dollar-funded and therefore did not participate in those markets.

Mr Jonathon Dixon, Head: Insurance Division, Financial Services Board, said that with regard to the insurance sector and the impact of financial regulations on competition and inclusion, it had happened in the past that financial stability and financial inclusion were regarded as antagonistic, but they were now viewed as complementary. New institutions, like micro insurance institutions, would bring insurance products to people who did not previously have access to insurance. Regulations for these products with simpler risks should be easier, while larger risks should have scaled up regulations. Assessing the risks that light regulations posed to customers, and deciding what the right level of regulations were, was one of the issues that was being globally debated by the industry. Financial regulation and insurance regulation were becoming a global industry.

Ms Katherine Gibson, Chief Director: Market Conduct, National Treasury, said there was a recognition that the authorities had a role to play and now countries were seeing newer, less traditional regions being accessed, including regions that previously did not have access to these markets.

Mr Momoniat said one of the major points in Twin Peaks was the supervision of conglomerates. However, lest people become complacent, it was necessary to remind everyone that it was approximately a year ago that the African Bank event had occurred. Even if SA had been ahead of the curve with regard to credit regulations ten years ago, it was currently behind the curve, as other countries had become much more intrusive.

Regarding ownership in the financial sector, he said that more than half of all companies on the JSE were foreign owned, and this ownership was also mainly by institutions. There was less individual ownership because of a lack of saving in SA.

Insofar as banks and the issue of capital and risk were concerned, he noted that it was not exchange controls that had a particular impact. Banks were more concentrated ,but they were also conservative, had a risk management culture and did not gamble. The IMF disagreed on the issues of concentration and safety and these were issues that needed to be looked at.

Mr Momoniat described the main findings of the Financial Stability Board peer review of 2013, namely that there was poor inter-agency coordination and regulatory structure and that there were inadequate Over the Counter (OTC) derivative reforms.

The main findings and recommendations of the FSAP of 2014 were to reduce the systemic liquidity risk, to enhance group-wide supervision to manage credit, to enhance the regulation of collective investment schemes, to enshrine in legislation the objectives, operational independence and enforcement powers of supervisors and to step up the surveillance of OTC derivatives markets.

The FSAP priority recommendation areas were in architectural reform (Twin Peaks, micro and macro prudential policy, crisis management, OTC derivative markets reform and competition and market structure).

Mr Roy Havemann, Chief Director: Markets and Securities, National Treasury, said that National Treasury would be releasing a paper in the current week setting out how it proposed to strengthen resolutions frameworks for situations when banks failed, and to have a solid approach to deal with such matters. It would also deal with the introduction of a deposit insurance scheme. National Treasury would be publishing the final regulations for OTC derivatives by the end of the year, to ensure a reduction in risk to financial systems posed by derivatives. The Market Conduct Act would cover the other portion of Twin Peaks and would propose new ways for banks to enter and exit the system. In addition, the Banks Act would be coming up for review.

Mr Momoniat said that the financial sector would be experiencing "an explosion of legislation". With Twin Peaks and the Banks Act review there would be new ways of dealing with banks and other institutions, especially if they posed systemic risks. He anticipated that three years worth of legislation would appear before the Committee.

The Chairperson said the Committee needed a keener appreciation of the relationship between Twin Peaks and the other Bills.

Mr Van Wyk said that many of the Basel III core principles for effective banking supervision in the Detailed Assessment Reports (DARs) were to do with capturing in legislation what was already being practised currently.

Mr Dixon then spoke to the insurance core principles, and said that of the 26 principles, six were fully observed, 11 were largely observed (90% compliance) while nine were partly observed, and in these areas there was a need for concentration of effort. Measures taken to address these concerns were the Solvency Assessment and Management (SAM) framework, which was the insurance equivalent of the banking sector's Basel III. An insurance bill would be brought to the Committee after the financial sector regulations bill.

Mr Momoniat said that, after dealing with the banking and insurance legislation, the next legislation would be securities legislation. The difference with securities standards was that part of it was dealt with by the regulated financial sector, but another part of it was also regulated in the non financial sector. Non- JSE listed companies were regulated by the Companies Act. Other regulatory bodies that were stakeholders were the FSB and the National Prosecuting Authority.

Mr Burt Chanetsa, Executive for Investment Instruments, FSB, gave an introduction to IOSCO, saying it was a collection of securities regulators which regulated standard setting for securities, with the IOSCO principles acting as the benchmarks. This provided protection for investors and ensured that markets were fair, transparent and had reduced risk. The Financial Services Board had been a member of IOSCO since 1992. He said there were gaps regarding unlisted public companies and acknowledged that reporting deadlines were slower when compared to the world averages. There had been recommendations on changes to be made to the Companies Act, but this could not be done alone, and the support of National Treasury and the Department of Trade and Industry were needed. The FSAP findings would be addressed, as they were all valid.

Mr Momoniat said National Treasury could not do the criminal part of investigations, but could only refer that side of matters to the proper authorities.

Mr Chanetsa added that another issue was that the burden of proof was far greater in a criminal court.

Mr Jurgen Boyd, Head of Collective Investment Schemes, FSB, spoke to the main areas of concern and the measures taken to respond to them.

Mr Pieter Smit, Head: Legal Policy, Financial Intelligence Centre, spoke to the Technical Note on money laundering and combating the financing of terrorism. The review required compliance with measures that should be in place to deal with money laundering. Those measures and standards were found in the Financial Assessment Task Force (FATF) recommendations. However, this was not approved because standards were relatively new at the time and had been substantially revised before assessments had taken place. SA regulations were still based on the previous standards. The Technical Note gave recommendations to align regulations to the new standards. The regulations were a mix of institutional regulations underpinned by legal requirements. The main recommendations and responses were to conduct a national assessment of money laundering and terrorist financing risks, and to require financial institutions to identify and verify the identity of beneficial owners in line with the standard.

Mr Momoniat commented that even football transactions had been investigated.

He concluded that it would thus be obvious that FSAP was a massive exercise related to prudential and enforcement issues and needed to be responded to. The issues went beyond just the National Treasury, and included the Department of Trade and Industry and the National Prosecuting Authority. Cabinet had agreed on the need to respond to the FSAP, and each of the booklets needed a clear response. National Treasury was meeting with non core stakeholders and intended to finalise responses before the end of the year. Twin Peaks would be done before the FSAP. He summarised that the idea behind this presentation was to allow the Committee to get an appreciation of FSAP, so that it could help them better understand Twin Peaks.

Ms Khoza asked how ready South Africa was to move to the Twin Peaks arrangement. She also wanted to know if there was a programme to build up the capacity of law enforcement agencies.

The Chairperson asked whether the National Treasury expected the new legislation to be finalised before the end of the financial year. He said the Committee needed a keener sense of how all the bills were connected.

Mr D Van Rooyen (ANC) referred to issues of revenue leakages, base erosion and transfer pricing, and asked whether the IMF saw this as a threat. He also asked if Twin Peaks was outside of this approach?

Mr Schimmelpfennig said that, as an institution, the IMF had not done a detailed review. His opinion was that it was not a major issue. The OECD countries were looking for a solution. In relation specifically to SA, he had not seen that being used through the banking system, as it would have been obvious.

Mr Momoniat said the tax issue was dealt with through the tax side. He thought that it would be difficult to nearly impossible for banks to hide money.

Ms Khoza asked if any risk assessment had been done on risk arising from SA companies expanding into the continent.

Mr Momoniat said the FSAP did discuss it and said it posed a risk. There was worldwide consensus that banks could not operate if they could not deal with banks in other areas of the world. Previously it had been an issue of development, but now banks were being punished if they did not improve their stability. He could not comment on the capacity of law enforcement, knowing too little on that issue.

Mr D Maynier (DA) said the DA’s priorities did not include the Twin Peaks legislation.

Mr Momoniat said the first bill was almost complete and the State Law Advisors would be looking at it. He encouraged the Committee to undertake study visits to see how other countries were dealing with the challenges.

The Chairperson said that if the Committee went overseas it would only be to look at a specific set of issues. The Committee acknowledged that no bill was as yet formally before the Committee, but this would not stop the Committee from starting to tackle conceptual issues before the bill was tabled.

The meeting was adjourned.

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