ATC071023: Report on Annual Report 2006/2007 of the Financial Services Board
Report on the Hearing of the Portfolio Committee on Finance on the Annual Report 2006/2007 of the Financial Services Board (FSB)
The Portfolio Committee on Finance met on 23 October 2007 to consider the Annual Report 2006/2007 of the Financial Services Board (FSB).
The Annual Report was presented by the Executive Officer of the Financial Services Board. After the presentation discussions followed which are recorded below.
Recommendations based on the engagement of the Committee with the FSB are provided in the final section.
2. Risk-Based Supervision
The Committee enquired what model is used in risk supervision, and whether the approached followed prioritised high-risk entities as there appears to be a low number of inspections in long-term insurance and collective investment relative to the value of the assets managed by entities. The Committee also raised concerns about the difference between on-site visits and inspections, and whether failure to submit reports led to inspections. The Committee noted that some of the responsibility for inspections was outsourced and enquired how the FSB was dealing with sensitive information, and what mechanisms were in place to ensure the integrity of the information.
The FSB responded that in 2004 it had adopted risk-based-supervision. Given the limited resources and the extent of its regulatory and supervisory responsibilities, there was clearly an imbalance between what the FSB needed to do and the resources it had available to do this. Some form of risk-prioritisation was therefore required.
The FSB approach entailed ‘risk-weighting’ each of the supervised institutions - the risk rating then determined the nature of the interaction between the FSB and a company. Where the risk-weighting was low interaction would be less frequent than in the case of an institution characterised by significant risk of one form or another.
Certain levels of risk would immediately result in an on-site review. Following an on-site review, if fraud or corruption were detected, an inspection would be called for, as enabled by the Inspections Act. This was a more drastic form of intervention.
In some instances aspects of an inspection needed to be outsourced - this occurred where FSB resources were being fully utilised elsewhere or where the FSB did not possess the particular skills required. In the experience of the FSB there had never been a problem where outside supervision had led to sensitive information being released. The FSB primarily outsourced to specialists, like chartered accountants, and also outsourced work that required highly specialised skills such as computer forensics. The FSB was of the opinion that it was not outsourcing its ‘core work’.
3. The Road Accident Fund
Regarding the investigation of the Road Accident Fund (RAF) the Committee noted that essentially the RAF was insolvent. The Committee asked what the reasons were for the RAF to be insolvent.
The FSB responded that this was quite a difficult case and confirmed that the RAF was indeed insolvent. Some steps had been taken to rectify the situation, but from the perspective of the FSB their report could do no more than refer to the financial situation of the RAF. The FSB did not do extensive, detailed work on the fund and in fact the question why the FSB was required to supervise the RAF was worth asking, as the RAF was not an “insurance company’ in the traditional sense.
Regarding ‘inducements’ offered by companies to prospective customers, and as mentioned in the FSB Annual Report, the Committee enquired whether such practices were prevalent in some of the industries or were they limited to isolated incidents?
The FSB noted that there were many situations where customers were confronted with inducements. The most familiar one currently was probably the cell phone that came with many cell phone service contracts. However, legislation prohibited using inducements in the case of insurance polices because, unlike a cell phone contract, such polices were for life. One did not want a situation where potential customers were being ‘overinduced,’ that is purchasing insurance more for the inducement than the policy itself.
5. Accumulated Surpluses
Referring to the accumulated surpluses reported on in the financial statements, the Committee enquired why there was a huge accumulated surplus at a specific time. The Committee also noted that there had been quite a substantial increase in levies and enquired how the levy rate was determined, and whether industry members who paid these levies were happy with the FSB’s accumulated surpluses.
The FSB responded that the levy income provided for in the budget was based on ‘old’ statistics, for example the extent of the assets and liabilities of a particular entity based on information available at the time. However, when actual income was collected there was sometimes a divergence: so invariably there was over-recovery of levies. This could also be attributed to the fact that the size of industries, that is of the levy base, had grown. For the period under review the FSB had decided to rebate R 23 million of a levy surplus of R 61 million.
6. FAIS Ombudsman
Regarding the FAIS Ombudsman, the Committee enquired whether this would in future be budgeted for, and, whether, levies would be raised to fund this office?
The FSB indicated that previously this office was accounted for in the balance sheet, but that the FSB’s auditors had advised that this was an incorrect way of accounting for it: it should instead be reflected on the income statement. This would be done in future.
7. Employment Equity
The Committee referred to the fact that the Annual Report provided no details on the disability and other employment equity targets set by government, and asked the FSB to please provide details on this.
The FSB responded that it was doing everything it could. The FSB did have a blind actuary, for example. Admittedly they were not close to the 2% target, but they were aiming for it. A particular problem in the case of the FSB was that not all its buildings catered for people with physical disabilities. The new premises that they were probably moving into in 2009 would cater for this.
8. FSB Success Stories
The Committee noted that cases such as Fidentia represented failures to detect and address wrongdoings. The Committee wondered to what extent the FSB had success stories when it came to finding perpetrators. There were no successes that were reported on in the Annual Report.
The FSB noted that the executive committee had in fact had a strategic workshop where precisely this issue was also discussed. The question that had been posed there was whether the FSB was doing enough to publicise its successes. The answer was clearly not. The FSB had not yet decided whether it should for example employ a ‘spin doctor’ or a public relations officer to ensure that the public was aware of what it was achieving. However, the FSB assured the Committee that it had achieved a great deal. The FSB’s point of departure was always to try to get back for investors what they had lost, and indeed there had been numerous successes in this regard.
Even after the FSB had recovered what needed to be recovered for investors it still handed cases over to the NPA. The NPA had a high case load, however. The currently existing enforcement tribunal dealt with cases and recovered funds and issues administrative sanctions covered only by the Securities Act. Soon the FSB would request of the Committee that it be permitted to establish FSB-wide enforcement tribunals so that cases could be dealt with expeditiously through this mechanism. The Committee requested that the FSB should report on its successes in future Annual Reports.
9. Repayment of Surplus Apportionments
The Committee referred to the reference in the Annual Report to the fact that there was some resistance amongst some pension fund administrators to paying back ‘secret profit’ funds. The Committee enquired what the FSB was doing to speed up the process. Were any further measures going to be considered in the future if the response rate remained poor?
The FSB responded that this issue had been an ongoing battle between itself and the industry. Some legal positions that were taken by some industry service providers also complicated matters: legal clarity had had to be obtained on some issues, causing further delays. The FSB had subsequently gone back to the industry supported by the increased clarity associated with the Pension Fund Second Amendment Act and was certainly expecting improvement in paybacks as a result.
The chief actuary, through interaction with the industry, was also trying to improve submission rates. The FSB hoped that the additional powers conferred on the registrar would enable more of a ‘big stick’ approach. Ultimately the issue remained that where funds were penalized the penalty would fall on the fund rather than the trustees who were the difficult parties. However, administrators could now be fined rather than the fund, which was a power brought in by the amended act and which gave the FSB increased power. Fines could now be up to R 5 million a day.
The Committee enquired whether the FSB was able to establish how far back these pension fund practices went, and whether the records were sufficient to establish amounts due so that corrective action could be completed.
The FSB responded that it went back quite a long way, to the mid-1990’s, and that it wasn’t difficult to identify when it started because it coincided with the introduction of cash management systems within pension fund administrations.
10. Consumer Education
The Committee enquired what the strategy of the FSB is to reach out to the most rural areas, noting that these often consisted of marginalized people who do not necessarily have insight into some forms of complex financial and insurance issues.
The FSB indicated that its strategy was multi-pronged - one aspect was to get better financial awareness programmes into school curriculums, and there had been interaction between the FSB and National Department of Education in this regard.
Another aspect was the extensive distribution of consumer education booklets that were being produced by the FSB. These were targeted more too rural areas. These booklets were produced in Sotho, Nguni and English. They were generally distributed through obtaining sponsorship from some supervised entities.
The Committee commented that perhaps the FSB should not rely on sponsorship to fund such initiatives but that they should be funded through the budget. The Committee further enquired what the measurements of success were regarding consumer education, and to what extent was there awareness of the FSB and its activities. The Committee noted that FSB offices needed to be located where it could be accessible to the marginalized, and that the booklets were not enough.
The FSB referred to the Annual Report where it was stated that the problem with consumer education was that one could spend a lot of money and not know if it was being spent well. The FSB was presently conducting research regarding how to go about effective measurement of consumer education Initiatives.
11. Promoting the Macroeconomic Environment
The Committee noted the important role the Financial Services Board had to play in promoting a strong macroeconomic climate by ensuring confidence in the financial sector of South Africa and enquired whether the FSB was competent and effective in this regard. The Committee noted that the industry opinion survey that had been conducted, indicated that 72% of clients were satisfied with the FSB with 28% not. The Committee enquired into the main reasons why some clients were not satisfied and how the FSB would address the matter.
The FSB stated that it believed it could say without hesitation that it was contributing to the macroeconomic climate by enhancing faith in the financial services sector. It was, however, also difficult to ensure that no problems existed in the sector.
Regarding the score of 72%, the FSB pointed out that it was not a commercial organisation that was aiming for a higher approval rating than this. It was, after all, a regulatory and supervisory body. There were inevitably firms that had been on the receiving end of regulatory action and that in consequence regarded the FSB more negatively.
Regarding international norms for approval ratings of an entity such as the FSB, the FSB indicated it had in fact asked the consultants who conducted its survey what the international benchmarks for industry satisfaction were. They had, however, replied that an entity such as the FSB was quite unique. They did, however, also indicate that any commercial organisation would be proud of the degree of client-satisfaction received by the FSB.
12. The FSB Balance Sheet
The Committee enquired how appropriate the structure of the balance sheet was for an organisation like the FSB. It noted that the use of rebates was good, but that the FSB was still retaining a large share of funds for itself. The Committee raised concern about the FSB not being too risk-averse for an entity that was protected by law.
The FSB pointed out that its contingency reserve actually represented less than 6 months of operating expenditure. It was reasonable that the FSB’s contingency reserve should cover 3-6 months of such expenditure. These were normal guidelines, within which the FSB worked.
The FSB, though, had various forms of reserves. There was firstly a contingency reserve which was limited to a maximum of 10% of gross income. There was also a discretionary reserve consisting of income from fines, which was used to fund consumer education initiatives. Lastly, there were general reserves: these were unlimited.
Regarding the related question of the investment portfolio held by the FSB, the FSB pointed out that this stemmed from a long-term liability the FSB had to fund retirement benefits of some retired employees. Because it was a long-term liability the FSB had decided to establish a long-term investment portfolio to cover it. The portfolio was managed independently so that any risks of insider trading were eliminated. At presents the value of the fund’s assets was double its liabilities.
13. The FSB Remuneration Policy
Regarding the FSB’s remuneration policy, the Committee referred to the call by the Governor of the Reserve Bank to maintain rates of remuneration equal to or below the inflation rate. It noted, however, that the remuneration of senior executives had increased by about 25% during the period under review and that of staff by almost 9%. The Committee requested that the FSB comment on what the remuneration policy of the FSB was and how it was determined.
Regarding performance bonuses, the Committee noted that during the period under review there had been a number of market failures and enquired how this equated with the significant performance bonuses paid out to FSB staff and executives, given its role as regulatory and supervisory entity. The Committee further enquired why it was indicated that the top 25% of staff received performance bonuses, whilst all the executive committee members received them. A related question was how the bonus amount as a percentage of total remuneration was determined, since this appeared to vary quite significantly by executive committee member.
The FSB noted that its remuneration policy consisted of two parts, namely that which dealt with straight remuneration and that which dealt with the determination of performance bonuses.
Regarding straight remuneration, the FSB needed to attract specialised skills and needed to retain the skills that it had. Accordingly, the FSB policy was not to pay what the market paid, as such, but to pay market-related salaries. If it did not do so, it would lose its skilled staff to the very entities that were being regulated. The FSB had to date largely succeeded in retaining staff.
Regarding performance bonuses, clearly top performers had to be rewarded. The FSB’s board had initially said that only the top 20% of staff should receive performance bonuses. The executive committee had argued against this with the board because strict adherence to such a percentage would mean, in reality, that most of the bonuses would be paid out to white employees. There had to be a mechanism, or an allowance made, for recognising outstanding performance relative to a current endowment of skills. As more convergence of skills occurred between black and white employees the 25% figure would be decreased. That is, this would happen when the racial mix of top performers was where it needed to be from an equity perspective. This 25% of staff receiving performance bonuses excluded members of the executive committee, whose remuneration was determined by a sub-committee of the board which executive committee members were not part of. In the case of executive committee performance bonuses, the sub-committee of the board again recognised that at executive level some incentives had to be provided to attract and retain staff. Bonuses were calculated using a market-related benchmark level, adjusted by a measure of individual performance.
14. Staff Retention Measures
The Committee referred to reports that there was a fair amount of poaching of staff occurring, and asked what corrective or preventive measures were being taken by the FSB. It was not enough to merely pay staff ‘market-related’ salaries in order to retain them. Were there any forms of skills development, internship, learnerships and the like?
The FSB noted that it did have a staff retention programme which had provided extensive additional training to staff. An internal staff opinion survey indicated a very high regard for training and development opportunities available to them. Such measures did help to retain staff. However, it needed to be appreciated that the FSB was to some extent a training ground before people left for positions in the industries themselves. Although the FSB paid market-related salaries, which was legally provided for through the Financial Services Board Act, it could not match the large incentives that were being paid in the financial services industry.
Regarding the employee band consisting of junior management and professional staff, the Committee referred to what appeared to be a fairly high staff turnover rate.
The FSB emphasised that all organisations at times experienced difficulties with recruiting the right people. The FSB relied heavily on employing newly qualified graduates and developing them to senior level. In effect, all its newly qualified graduates that were employed were learnerships.
The FSB further noted that too little staff turnover could also become a problem as there were then not enough new opportunities available to staff. It further needed to be noted that within the FSB it was not the top people who left. A last point was that the more rigourous measurement of performance was within an organisation, the more people would be ‘lost’ who were not performing well.
15.1. The Committee recommends that the FSB report quantitatively in its Annual Reports on what had been and what had not been achieved with regard to employment equity with special reference to people with disabilities.
15.2. The Committee recommends that the FSB give consideration to funding consumer education initiatives through its budget rather than relying on sponsorships.
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