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10 lines on a piece of paper

Financial sector conduct and consumer protection – getting the regulation right.

In December last year National Treasury released the draft Conduct of Financial Institutions (Cofi) Bill. The industry expects this bill to be signed into law before the end of 2019.

Cofi follows the establishment of the ‘Twin Peaks’ regulatory regime in South Africa. The country now has two regulators in the financial industry – the Prudential Authority, responsible for ensuring the stability of the financial system, and the Financial Sector Conduct Authority (FSCA), which is in charge of regulating market conduct and consumer protection.

The latter is the sphere in which Cofi will be relevant. It sets out how financial firms must act, not through imposing a traditional, tick-box approach, but rather through a focus on the outcomes they provide to their clients.

Separate, but equal

Dr Andy Schmulow, a senior lecturer at the University of Wollongong in Australia and a senior advisor at local management consulting firm DB & Associates, is a member of the expert panel advising National Treasury on Cofi. He believes that the need for this type of regulatory regime has been well established.

“We have understood clearly that failures in prudential regulation can very quickly become a crisis, but we now also understand that market misconduct and consumer abuse can also become a crisis,” Schmulow says. “The global financial crisis began with the sub-prime disaster, which was market misconduct and consumer abuse writ large.”

Separating prudential regulation and conduct regulation is therefore, in his opinion, a logical step.

“Protecting consumers and upholding prudential regulation are antithetical,” Schmulow believes. “You can do one, or you can do the other, but you can’t do both. We learned that for regulators who had been mega regulators, who had tried to do both, one of those imperatives had always won the day.”

For example, it is in the interests of consumers to promote competition. That should encourage a conduct authority to issue more banking licences. A prudential authority would, however, more likely do the opposite since smaller, more weakly capitalised banks could be a threat to systemic stability.

“So you have to separate the two and make them equally powerful,” Schmulow argues. “You have to give them jurisdiction so that they can do their job.”

The failure of self-regulation

Significantly, it has also become apparent that the industry cannot be left to regulate itself.

“You have to provide a regulatory framework for regulating conduct, and you can’t abrogate that responsibility to individual entities,” Schmulow says.

‘The only time that industry self-regulation will work is if it rests on very strong foundations – that if you don’t obey the law, we will send you to jail. Take that away and industry self-regulation becomes intellectually dishonest and theoretically bankrupt.’

Before the financial crisis, the dominant thinking was that the financial services industry would be naturally self-regulating. The argument was that the market itself would impose the ultimate control on behaviour. Entities would understand that it was in their own long-term self-interest to act in the best interests of their customers and protect the sustainability of financial markets.

However, the experience of 2007 and 2008 has shown that long-term thinking is easily overridden by the possibility of short-term gains.

Cofi seeks to solve this by providing clear, customer-centric standards for the industry. It also gives the conduct regulator the power to enforce them, making it distinctly different to the treating customer’s fairly (TCF) regime that it will replace.

“TCF is a subjective framework, so you are asked to evaluate yourself,” explains Schmulow. “But Cofi is an objective standard, which the regulator can enforce.”

Regulatory burden

A concern among some commentators is that Cofi will further increase the already sizeable compliance requirements placed on financial services companies. This not only distracts them from what they should be doing, but creates barriers to entry, since the cost of compliance is so high.

Schmulow however believes that Cofi actually does the opposite.

“Those consequences are the consequences that come from a prescriptive, rules-based regulatory regime, where highly prescriptive rules have unintended consequences,” he argues. “That kind of regulatory paradigm doesn’t ever get slimmed down, only ever fattened out. You get more rules, and more granular, compliance tasks.

“That is not the regulatory paradigm being introduced here,” he adds. 

‘Cofi is a principles-based and outcomes-determined regulatory paradigm. It is conceivable that you could slim that down to 10 lines on one piece of paper.’

What is critical for industry players to understand is that this requires them to think very differently about compliance. It is no longer about checking things off a list.

“Rather, you need to ask what are all the different ways in which we can be customer focused?” says Schmulow. “Let’s have a deep, probing, intelligent reflection about all the different places where there is a risk that we could be distracted from that aim.”

For instance, in the development of products, are firms coming up with new offerings just to make more money, or is there an identifiable customer need that can be met? Are products designed in a way that is fair and transparent, or are fees and charges being hidden?

“There are leading examples of companies that have gone through the pain of weaning themselves off flogging products, have become much more customer-focused, and have been well rewarded by the market,” Schmulow says.

“So this is not the end of entrepreneurial capitalism. What it is, is an understanding that the financial system is more of a linchpin than any other industry in not only ensuring a healthy and vibrant economy, but that the wealth in that economy is fairly distributed.”

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Oh my word. What utter claptrap!
It’s hard to know where to begin with all this confusing, contradictory drivel.
Cofi is by no streach of the imagination an “objective standard”. It is repleat with entirely subjective standards to be decided upon by wards of the state with little or no operational experience. Moreover, it is so full of basic violations of the rule of law that it is not going to pass constitutional muster – not ever.
As for the prospect of it ultimately being reduced to nine lines, this is not only extremely unlikely, the reality will be exactly the opposite as it is found to be close to impossible to implement in practice.
Although it is going to cost the nation and financial services consumers at least 10 years and several billion Rands, eventually sense will prevail and we shall return to the proper rule of law rather than this mish mash of the touchy, feely rule of man.

South Africa….KILLED by (more) regulation!

But not all is lost. The pressure must come from consumers…so what I propose is for all financial institutions (be it for FICA, RICA, FAIS, etc) is to starting charging a hefty document-pack fee 😉

Let’s start from R150 upwards, depending on complexity. Paid upfront off course. (Cell phone companies charge such fees for an upgrade/migration in any case…)

Such document-fees will pass the cost to the consumer, which is the source of consumerism pressure. Want consumer protection? Then PAY for it…! I’m happy with that.

It’s really quite simple.

Every industry that has a formal disciplinary or complaints body should have that body CHAIRED by a CUSTOMER representative.

And HALF the members of these bodies should ALSO be drawn from the the CONSUMERS of the “services” the industry purports to supply.

This immediately cuts out the SERIOUS conflicts of interest and other shenanigans that plague currently-constructed “disciplinary” committees, who all too often are really just a closed shop of industry representatives acting in their own selfish interests.

Recalibrating these bodies will be a powerful force for positive change that industry players will be FORCED to pay REAL attention to instead of just paying cynical lip service to.

Can start with this idea straight away with attorneys and insurance industry!

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