ATC211203: Report of the Select Committee on Finance on the Financial Sector Laws Amendment Bill [B15B - 2020] (National Assembly- section 75), dated 2 December 2021

NCOP Finance

Report of the Select Committee on Finance on the Financial Sector Laws Amendment Bill [B15B - 2020] (National Assembly- section 75), dated 2 December 2021

1.Background and Introduction

The Financial Sector Laws Amendment Bill (FSLAB) forms part of the Financial Sector Regulation Act (FSRA) or “Twin Peaks” regulatory reforms introduced in 2011, which covers the conduct and transformation of the financial sector.

As the National Treasury explained, the purpose of the FSLAB is to address banking risks, failures and weaknesses and mitigate impacts of financial crises. It seeks to address the shortcomings of the current financial legislation, partly necessitated by the lessons learnt from the 2008/09 global financial crisis and domestic experiences and to enhance the South African Reserve Bank’s (SARB) financial stability mandate and to expand its objective for depositor protection. It was further said that the South African lessons learnt from the African Bank and VBS demonstrated the need for additional powers during an intervention and an explicit, privately funded deposit insurance scheme to protect vulnerable depositors.

Since 2011, the regulatory reforms led to a promulgation of the Financial Markets Act 19 of 2012, the 2015 Banks Amendment Act in response to the African Bank failure and other Acts meant to regulate the financial sector.  National Treasury expects these reforms to make the financial sector safer for the economy and customers by minimising the use of public funds and reducing moral hazard.

National Treasury, the SARB and the Financial Sector Conduct Authority (FSCA) published several framework and position papers and policy and discussion documents between 2011 and now, in support of proposed amendments in the Bills introduced. In addition to the FSLAB, National Treasury planned to introduce the Conduct of Financial Institutions (CoFI) Bill in Parliament in 2021, which will provide, amongst other things, an important aspect of transformation in the financial sector.

With regards to the process followed by the Committee, on 07 September 2021, the National Council of Provinces (NCOP) formally referred the FSLAB to the Select Committee of Finance (SeCoF), for consideration and report, after the Standing Committee on Finance (SCoF) voted on it. The National Assembly (NA) passed the Bill on 06 September 2021. The SeCoF received a briefing from National Treasury and the SARB on 15 June 2021. The Committee then received written submissions from Congress of South African Trade Unions (COSATU), Banking Association of South Africa (BASA), Free Market Foundation (FMF) and the Association for Black Securities and Investment Professionals (ABSIP). On 10 November 2021, all stakeholders, except for ABSIP, made oral submissions to the Committee in virtual public hearings. National Treasury and the SARB responded to the oral submissions made on the same day and later provided written responses. The Committee held a meeting on 30 November 2021 to deliberate on the policy aspects of the Bill and on 02 December 2021 to adopt the report.

2.Overview and objectives of the Bill

The objective of the FSLAB is to amend the Insolvency Act, 1936, the SARB Act, 1989, the Banks Act, 1990, the Mutual Banks Act, 1993, the Competition Act, 1998, the Financial Institutions (Protection of Funds) Act, 2001, the Co-operative Banks Act, 2007, the Companies Act, 2008, the Financial Markets Act, 2012 and the Financial Sector Regulation Act, 2017. These Acts are amended for various reasons including to provide for the establishment of a framework for the resolution of designated institutions to ensure that the impact or potential impact of a failure of a designated institution on financial stability is managed appropriately; to designate the SARB as the resolution authority; to establish a deposit insurance scheme, including a Corporation for Deposit Insurance and a Deposit Insurance Fund; to provide for co-ordination, co-operation, collaboration and consultation between the Corporation for Deposit Insurance and other entities in relation to financial stability and the functions of these entities.

Key objectives of the Bill detailed by the National Treasury are as follows:

2.1Establishment of a framework for resolution of banks

The FSLAB proposes to introduce a new Chapter 12A to the FSRA 2017, that will establish a framework for resolution of designated institutions and a deposit insurance scheme. As National Treasury and SARB clarified, the aim of creating a resolution framework is to ensure that the impact of a failure by a bank, or systemically important financial institution, is managed in an orderly manner. National Treasury asserted that a speedy resolution of the institution could be a more appropriate action than the current framework, which primarily entails curatorship, business rescue proceedings and to a lesser extent, judicial management. Resolution in an orderly fashion, managed and controlled by the SARB, affords greater protection to depositors and taxpayers, who might otherwise have to foot the bill to keep a financially distressed institution afloat, National Treasury further said.

2.2Designating the SARB as the Resolution Authority

The Bill proposes that the process of resolution takes place under the management and control of the SARB, which will be the Resolution Authority. Resolution, as defined by the National Treasury, refers to a process during which a competent authority, the Resolution Authority, takes over the control and management of the affairs of a designated institution that is failing or likely to fail in order to restructure or resolve the institution with the use of resolution tools in a manner that seeks to protect financial stability and minimise the reliance on public funds.

2.3Deposit Insurance Scheme

The Bill proposes the establishment of a Deposit Insurance Scheme, which includes a Corporation for Deposit Insurance and a Deposit Insurance Fund. From a policy perspective, National Treasury expects the scheme to ensure protection for depositors in bank failure, provide a safety net for ordinary depositors, minimise disruption and adverse effects of failures and act as a crisis management tool available to the SARB. The Scheme will be housed within the SARB.

According to the National Treasury, the Deposit Insurance Fund would help to ensure that holders of covered deposits at a Bank in resolution will have access to their funds; limit severe financial hardship for bank depositors; promote competitiveness of smaller banks; ensure continued access to funds during a bank failure; and limit the exposure of public funds to the cost of a bank failure, amongst other things. The Fund would be financed by an annual deposit insurance levy charged and collected from the members of the fund, premiums from licensed banks, which are members of the Corporation for Deposit Insurance and provision of liquidity by the SARB. The Corporation will be tasked with the administration of the Fund.

2.4Creation of creditor hierarchy

The Bill proposes creation of a creditor hierarchy to ensure depositor protection in an event of liquidation and adherence to the “no creditor worse off” principle. National Treasury’s rationale is that the current South African creditor hierarchy does not recognise distinction between ordinary depositors using a bank for transactions, and informed creditors and depositors making an investment in a bank for a return.

3.Public participation process

This section summarises the oral and written submissions received by the Committee, organised in terms of key concerns raised by the four stakeholders and the recommendations made thereof.

COSATU welcomes the FSLAB in principle and believes that it is a necessary and long overdue intervention by government, that would help protect workers, pensioners, the state and the economy. In particular, COSATU supports various provisions seeking to capacitate the state, the SARB, the FSCA and National Treasury to oversee the financial sector, hold banks accountable and where necessary to intervene and the depositor’s insurance.  These interventions will help to protect workers, pensioners and other depositors from the worst effects of the collapse of bank, COSATU submitted. 

ABSIP is in full support of the amendments proposed in the FSLAB and its overall stance on the amendments proposed by the National Treasury is that the Bill should broadly cater for transformation, encourage competition in the financial sector and support the imperative for a black economic empowerment strategy by not allowing important institutions to fail. ABSIP cautioned the National Treasury on areas of governance and transparency and proposed explicit provision on the criterion for designated institutions. It further opined that the bailouts should be on merit and case-by-case basis following the SARB Governor's consultation with the Prudential Authority and advice from the appointed investigator.

3.1Summary of key issues raised by the stakeholders

• FSLAB provides an unhelpful definition of “resolution”, which is also not clear or accessible, vague and violates the rule of law. A further concern is that while the memorandum on the Bill’s object describes resolution, the Bill does not say it;

• Passing of the Bill is occurring at a slow pace;

• The Bill would not remove the moral hazard that might be created by insurance and government bail-out;

• The Bill amends the FSRA and that will allow Banks to pass insurance costs on to customers;

• The Bill can merely assist in maintaining financial stability as far as practicable;

• The Bill gives the SARB a subjective discretion which violates the Rule of Law, for instance, regarding powers of the SARB, it can recommend resolution if in its opinion a Bank will likely be unable to meet obligations, or it can cancel unreasonably onerous contracts;

• The proposal in the Bill to amend the FSRA such that the SARB may direct the Prudential Authority to require a specific Bank to hold flac instruments contradict the Basel Financial Services Board (FSB), which states that resolution entities should issue and maintain (not hold) Total Loss Absorbing Capacity (TLAC) instruments, and third parties should hold them;

• The SARB’s sweeping powers can fail, just as a resolution can fail;

• In its current form, the Bill is vague and it is unclear what the SARB would seek to achieve in the interest of both the designated institution and its affected creditors;

• The proposed amendment in Clause 166 (W) (2) (A, B and C) of the Bill, which provides for ranking of claims for creditors, was believed to be wrong, immoral and in contravention of the Constitution’s requirements for legislation to be equitable, fair and rational as it delays the unsecured creditors in accessing their savings;

• There exists a contradiction in the provision made in the Insolvency Act and the Constitution that implies that all creditors should be treated equally. While the creditor's hierarchy may guide the process of claiming by the creditors, the Resolution Authority needs to ensure that “no creditor is worse off”;

• The Bill does not define creditors who might bear losses first or mention which creditors are able to properly assess their investment risks or benefited from profits,

• Section 166S(9), Prime Finance Agreements carve outs, do not cover securities lending and repurchase agreements, as such agreements clearly do not fall within carve outs (a), (c) and (d), where (a) an unsettled exchange traded transaction; (b) derivative instrument (as defined in the Financial Markets Act 2012 (“FMA”)); (c) deposit where the deposit holder is the Corporation for Public Deposits and (d) an unsecured transaction between two or more settlement system participants as defined in the National Payment System Act; and

• Prime Finance Agreements do not fall within the definition of a “derivative instrument” in the FMA (carve out (b)).  This is because the rights and obligations arising under Prime Finance Agreements do not depend on the value of underlying assets, rates, indices or measures of economic value or a default event. Rather, Prime Finance Agreements document shadow banking products which are not considered to be derivative instruments by the market or the regulators both on a global and a local basis.  This means that transactions under Prime Finance Agreements effectively become subject to the Resolution Powers and can be amended or cancelled by the SARB.

3.2Some recommendations made by the stakeholders

• The Resolution Authority should broaden its scope in its concept of "too big to fail" to also cover the transformation imperative and strategy;

• Make a provision stipulating the amount and threshold of insolvency and the criteria that will determine an institution being placed under the Resolution, in line with international best practices and certain financial institutions;

• Publish the resolution process to ensure that there is clear access to information and transparency;

• The proposed objectives of the Resolution Authority as stated in Section 166B&C are satisfactory, however, clearly stipulate time frames for activities that are specified in the Act;

• Banks need to submit an annual failure management strategy and plan that states how banks plan to protects depositors; and

• The Bill needs to stipulate which creditors are covered in the Deposit Insurance Scheme and the value creditors can claim in the event of the Bank or the designated institution in liquidation.

4.Responses by the National Treasury on issues raised by the stakeholders

In response to the issues raised by COSATU, National Treasury said that it notes the concern about protecting workers’ wages and benefits. National Treasury further said that it is guided by the approach in the Insolvency Act, 1936 (Act No. 24 of 1936), administered by the Minister of Justice. In engaging with the Department of Justice, National Treasury has been informed that the Act is being reviewed in an integrated and holistic manner.

The Department of Justice and Constitutional Development has confirmed that they are continuing with work on the Insolvency Bill, which would replace the existing Insolvency Act, 1936 (Act No. 24 of 1936) and they are in the process of seeking approval to publish an Insolvency Bill for public comment.  It would, therefore, be desirable for submissions regarding how workers’ salaries and benefits should be protected in the event of an insolvency (and not only in respect of Banks), to be considered and appropriately addressed in that legislative process in a very well-considered.

Section 98A of the Insolvency Act provides some protection of wages and benefits as follows: Salaries or wages of former employees of the insolvent, thereafter any balance of the free residue shall be applied in paying, (1) to any employee who was employed by the insolvent any salary or wages, for a period not exceeding three months, due to an employee; any payment in respect of any period of leave or holiday due to the employee which has accrued as a result of his or her employment by the insolvent in the year of insolvency or the previous year, whether or not payment thereof is due at the date of sequestration; any payment due in respect of any other form of paid absence for a period not exceeding three months prior to the date of the sequestration of the estate; any severance or retrenchment pay due to the employee in terms of any law, agreement, contract, wage-regulating measure, or as a result of termination in terms of section 38; and  (2) any contributions which were payable by the insolvent, including contributions which were payable in respect of any of his or her employees, and which were, immediately prior to the sequestration of the estate, owing by the insolvent, in his or her capacity as employer, to any pension, provident, medical aid, sick pay, holiday, unemployment or training scheme or fund, or to any similar scheme or fund.

National Treasury acknowledged that this is subject to the insolvency process, but submitted that it is also a matter that would also be relevant to consider and potentially be addressed in the Insolvency Act or successor legislation, and it would not be a matter that is beyond the appropriate scope of this legislation to address.

To FMF, National Treasury’s response was that the details related to “flac” will be addressed in accompanying standards and not the primary law. In this regard, SARB has published a consultation paper, which is available on its website and the Bill will come into effect at a date to be determined by the Minister.

On the issue of unclear definitions, National Treasury described Resolution as management of the affairs of a designated institution as provided for in Chapter 12A. This means that the SARB, once an institution is designated as being in resolution, may manage the affairs of the institution, in accordance with the requirements and procedures provided for in Chapter 12A, and it may implement resolution actions as provided for in section 166S.

National Treasury said that it is helpful to read and understand this definition in conjunction with the following definition, “orderly resolution of a designated institution” means the management of the affairs of the designated institution as provided in Chapter 12A in a way that (a) assists in maintaining financial stability; (b) ensures that the critical functions performed by the designated institution continue to be performed; and (c) in the case of a bank, protects the interests of depositors. The process of resolution must, therefore be applied in a manner that achieves the objectives set out in that definition. This is explained in the Memorandum on the Objects of the Bill as follows, “resolution is a process in which a Resolution Authority takes over control and management of the affairs of a Bank that is failing or likely to fail, in order to restructure or resolve that Bank with the use of resolution tools in a manner that seeks to protect financial stability and minimise the reliance on public funds”.

National Treasury therefore submitted that the definition of “resolution” is appropriate for the context of the Bill, when applied as intended in the context of the “orderly resolution of a designated institution”, and that it should not be necessary to amend the definition in the Bill.

On the issue of subjectivity of the SARB, National Treasury explained that this is the nature of prudential regulation, where the regulator has to make an assessment based on its own analysis. Such a recommendation is a judgement call based on evidence, and cannot be regarded as merely a “subjective” assessment. Even then, the regulator can only make a recommendation to the Minister in relation to whether it would be appropriate to place a Bank in resolution. It therefore does not constitute an administrative decision, and therefore the rule of law is not violated by making a recommendation to the Minister. The Minister would still need to consider the recommendation, and such recommendation has to be substantiated by facts that there is some likelihood that the Bank will be unable to meet its obligations. The Minister would make a decision regarding whether or not to place a Bank into resolution based on that recommendation, and the evidence supporting the recommendation, and applying his or her own mind to the decision. There necessarily has to be some degree of discretion exercised in relation to an administrative decision, and it is not possible for a decision to be made to be entirely “objective”.

National Treasury does not accept the proposal made, as it does not take account of how Banks are regulated globally, and differently, from other sectors of the economy, given that banking is based on trust and subject to a run on the bank. It then submitted that in contract law, the meaning of an onerous contract is quite well understood, and Black’s Law Dictionary defines the terms as follows: “onerous” - A contract, lease, share, or other right is said to be "onerous" when the obligations attaching to it unreasonably counterbalance or exceed the advantage to be derived from it, either absolutely or with reference to the particular possessor. Unreasonably burdensome or one-sided. It further submitted that the term is not “vague”, but that the term is sufficiently clear, and is capable of meaningful construction using the “reasonable person” test, which is another test that is applied for vagueness.

On issues raised by ABSIP, National Treasury said that it is important to note that whilst certain Bank curatorship provisions in the Banks Act may share similar traits with certain resolution provisions, the two processes are not the same and cannot be considered like for like. For example, the scope of curatorship is narrow and focuses on one institution whereas the scope of resolution is broader and focuses on the stability of the entire financial system. Curatorship has limited powers assigned to a curator whereas resolution envisages a broad set of powers including ‘bail-in’ that vest in the SARB as the Resolution Authority. Similarly, resolution (or curatorship for that matter) is not the same as insolvency. The protections in the insolvency framework for holders and creditors of certain financial instruments have to be considered from the view of the policy intention of each distinct framework. National Treasury and the SARB are committed to ensuring that South African financial sector laws are aligned with other international jurisdictions given the financial stability mandate of the SARB.

On the submission that the Resolution Authority needs to ensure that no-creditor is "worse off", National Treasury’s response was that the Bill contains various protections for creditors such as the “no creditor worse off rule” in clause 166V, that the SARB must not take a resolution action if the result of the action would lead to the value of the claim of a creditor being reduced and that when taking resolution action in relation to a designated institution in resolution, the SARB must treat claims of creditors that would have the same ranking in insolvency, equally.

National Treasury reported that the submission from BASA is under consideration and possibly resolvable outside of the ambit of the primary legislation. The National Treasury and the SARB met with BASA as directed by the Committee. National Treasury will publish a draft preliminary Standard, on the termination rights of agreements, in the form of a discussion document. Such publication will address the concern raised by BASA.

5.Observations

5.1Clarity on specific definitions

The Committee noted the stakeholders’ concerns that certain definitions in the Bill are unclear, vague and confusing and that there are some consistencies in the proposed amendments. These include the omission of the definition of “resolution” in the Bill, clearly defining the meaning of “financial stability”, protection of interests of depositors and provision of the definition and precise criterion of designated institutions.

5.2Deposit Insurance Scheme

The Committee noted that, according to the submissions made, the proposed amendments in the Bill would not remove the moral hazard that might be created by insurance and government bail-outs; does not stipulate which creditors are covered in the Deposit Insurance Scheme and the value creditors can claim in the event of the Bank or the designated institution in liquidation and that the amendments to the FSRA will allow Banks to pass insurance costs on to customers.

5.3Creditors hierarchy

We noted the issues raised on the proposed amendments of the Bill to create a ranking of creditors, which include the belief that the ranking of claims for creditors was wrong, immoral and in contravention of the Constitution and that the Bill does not define creditors who might bear losses first or mention which creditors are able to properly assess their investment risks or benefited from profits.

5.4Powers of the South African SARB

The Committee observed wide ranging concerns on the powers that the proposed amendments in the Bill afford the SARB. The issues raised include the subjective discretion that the Bill gives to the SARB in some instances, which violates the Rule of law; the fact that SARB’s sweeping powers can fail, just as a resolution can fail; and that in its current form, the Bill is vague and that it is unclear what the SARB would seek to achieve in the interest of both the designated institution and its affected creditors.

5.5Responses to issues raised by stakeholders

The Committee noted National Treasury’s responses to the issues raised by the stakeholders, particularly BASA’s withdrawal of concerns raised related to prime purchase agreements and that such concerns will be addressed in the preliminary Standard discussion document that would be published by the SARB.

5.6Rationale for proposed amendments

We noted that the proposed amendments in the FSLAB and its framework are (1) supported by best practices globally as well as domestic experiences, (2)  that National Treasury and the SARB conducted several studies, which include a Cost Benefit Analysis to determine the regulatory costs of compliance and benefits, amongst other things, in support of the proposed amendments (3) that even though the Bill does not explicitly deal with issues of transformation, it does advance principles of transformation and that the CoFI Bill which will be tabled later in Parliament, will provide for an important aspect of transformation in the financial sector.

6.Recommendations

The Committee supports the objectives of the FSRA, under which the current FSLAB falls. These objectives seek to maintain stability of the financial system; maintain soundness of regulated financial institutions; protect consumers of financial products and services; increase access to financial products and services; and combat market abuse and financial crime. The outcomes of which are expected to benefit the society in general including retail financial customers; financial institutions and their shareholders; poorest households; Small Medium and Micro Enterprises (SMMEs) and rural development programmes.

We also support the proposed amendments in the FSLAB which broadly, designate the SARB as the resolution authority; establishes a deposit insurance scheme and provides for co-ordination, co-operation, collaboration and consultation between different entities in relation to financial stability and the functions of these entities. These amendments are expected to, amongst other things, address banking risks, failures and weaknesses and mitigate impacts of financial crises.

We recommend that National Treasury and SARB continue to engage with the different stakeholders to address the gaps identified in the Bill and guard against the unintended consequences of the Bill.

The Select Committee on Finance, having considered and examined the Financial Sector Laws Amendment Bill [B15B - 2020] (National Assembly – section 75), referred to it, and classified by the JTM as a section 75 Bill, accepts the Bill.

 

The Democratic Alliance (DA) reserves its position.

The Economic Freedom Fighters (EFF) reserves its position.

The Freedom Front + (FF+) reserves its position.

 

 

Report to be considered