Introduction to special issue – the twin peaks model of financial regulation and reform in South Africa

Since 1998, almost 80% of OECD countries have changed their financial regulatory architecture.¹ Various factors, including the growing complexity of financial products, the increasing challenge of regulating large financial conglomerates, and the repercussions of the Global Financial Crisis, have made regulatory reform a key priority for many economies. One of the trends in recent years has been a move towards the Twin Peaks model of financial regulation. This model was pioneered in Australia and separates financial regulation into two broad functions: market conduct regulation (which includes consumer protection) and prudential regulation. Each of these functions is vested in a separate regulator. In Australia, market conduct regulation is vested in the Australian Securities and Investments Commission (ASIC) and prudential regulation is vested in the Australian Prudential Regulation Authority. The central bank, the Reserve Bank of Australia, remains responsible for monetary policy and financial stability, including ensuring a safe and reliable payments system. The model has subsequently been adopted by the Netherlands, Belgium, New Zealand (NZ) and the United Kingdom (UK). The model has also been considered by the US.²

There are at least two models with which the Twin Peaks model is generally compared. The first model, the “institutional model” focuses on the form of the regulated institution (e.g. a bank, insurer or a securities firm) and establishes a separate specialist regulator for that institution. Under this approach, the relevant regulator supervises all activities undertaken by the institution, irrespective of the market or sector in which the activities take place, and the institution is normally regulated by one regulator alone. The institutional approach is often referred to as an offshoot of the broader sectoral or “operational” approach, under which institutions are regulated by reference to the sector in which they operate or the products or business in which they engage. For example, where a financial institution offers banking products and life insurance, it might be regulated by both the banking regulator and the insurance regulator.³ The sectoral or operational model, like the institutional model, becomes increasingly difficult to operate as the complexity of financial products and financial institutions increases. This potentially causes coordination problems and regulatory overlap between the relevant regulators.

The second model, the “unified” or “super-regulator” model, attempts to address the problems experienced by the institutional and sectoral approaches by creating a single regulator to monitor both the conduct of market participants and the prudential soundness of financial institutions. This model was championed by the UK prior to its move to the Twin Peaks model. One of the perceived problems with this model, however, is that “[p]rudential and conduct of business … regulation require[s] fundamentally different approaches and cultures and there may be doubt about whether a single regulator would, in practice, be able to effectively encompass these to the necessary degree.”⁴ Another issue with the unified approach is that a single regulator “might not have a clear focus on the different objectives and rationales of regulation and supervision, and might not make the necessary differentiations between different types of institution and business.”⁵

The Twin Peaks model is considered to have certain advantages. First, the two peak regulators are more likely to have “dedicated objectives and clear mandates to which they are exclusively committed.”⁶ Secondly, there is less danger that one aspect of regulation – such as market conduct regulation – will come to dominate the regulatory landscape. Regulatory culture, which encompasses the attitudes, policies and practices adopted by regulators in fulfilling their objectives, can be fostered depending on the function of the regulator and the culture that it needs in order to perform its role effectively. This avoids the issue of having multiple “cultures” under the one roof, as might be the case with a super-regulator where different cultures arise because of different regulatory objectives. Thirdly, the model may be better adapted towards keeping pace with the growing complexity of financial markets and the continuing rise of financial conglomerates. Further, the Twin Peaks model may avoid the inherent conflict of interest that arises within a super-regulator. As was noted by the UK Joint Committee on the draft Financial Services Bill (JCFSB) in 2010:

[T]he evidence of the recent financial crisis suggests that mixing functions can contribute to a lack of focus on rising macro-prudential risk and difficulties in moving to a “war footing” when that risk becomes substantial. In addition, the incentives are different. For example consumer protection can be well served by keeping a bank open, while stability is well served by closing it.⁷

There are also perceived disadvantages of the Twin Peaks model. First, it may create regulatory overlap with dual regulated entities. This means that it is “inevitable that two separate regulators would have two separate rule books and two separate systems.”⁸ In the UK, it was noted in 2013 that “approximately 2,000 firms [would] be subject to dual regulation.”⁹ If not carefully managed, this could place a “considerable burden”¹⁰ on regulated entities and lead to poor information-sharing and coordination.

Secondly, there is a general risk that cooperation and coordination between the regulators will not be sufficient with potentially serious consequences. While these risks can be managed through robust coordination and liaison channels, it nevertheless remains a key concern for jurisdictions that have adopted the model.¹¹

A. The pathway to financial system reform in South Africa

South Africa initiated reforms to its system of financial regulation in 2011. This followed a review of the financial regulatory system that began in 2007 and culminated in a policy paper entitled “A safer financial sector to serve South Africa better”.¹² Central to the reforms was a move towards a Twin Peaks model of financial regulation. The legislation implementing the new model – the Financial Sector Regulation Act – was tabled in Parliament in October 2015 and was enacted in August 2017. Transitional arrangements have been adopted to implement the reforms, including the establishment of the Twin Peaks regulators: the Prudential Authority (PA), which is expected to be established in January 2018, and the Financial Sector Conduct Authority (FSCA), which is expected to be established in October 2018.¹³ The PA and the FSCA will sit alongside four authorities that will collectively have responsibility for financial regulation in South Africa:

• The South African Reserve Bank (SARB), which will be given new financial stability powers and will continue to be responsible for monetary policy, payment system oversight and the supervision of foreign exchange transactions;

• The National Credit Regulator, which was established in 2005 and will continue to be responsible for the market conduct regulation of all credit providers;

• The Financial Intelligence Center, which was established in 2001 to combat money laundering and the financing of terrorism and has a primary role in protecting the integrity of South Africa’s financial system; and

• The Ombuds, which operate pursuant to the Financial Services Ombud Schemes Act of 2004 and may ultimately be amalgamated into a single system of financial dispute resolution.¹⁴

The adoption of the Twin Peaks model by South Africa has been said to represent the “most significant financial sector reform for 25 years”.¹⁵ It will also constitute the first time that a developing country has adopted the model. The implementation of the reforms in South Africa will be undertaken in two phases. Phase 1 will focus on establishing the new regulators pursuant to the Financial Sector Regulation Act. Phase 2 will focus on how and what the regulators will regulate. This will involve the enactment of, and amendments to, legislation and the consolidation of regulations and standards that apply to the financial sector.

B. The papers in this special issue

This special issue brings together four papers that discuss the Twin Peaks financial regulatory model and related issues, including the reforms that are currently underway in South Africa. The papers were delivered by the authors at the “Twin Peaks Colloquium” in Pretoria on 28 September 2017. Hosted by the University of Pretoria Faculty of Law and chaired by Professor Corlia van Heerden, the Colloquium also included presentations from representatives of the National Treasury of South Africa, the Financial Services Board of South Africa and the PA of South Africa and from Professor Nick Huls of the Van Vollenhoven Institute, University of Leiden.

The four papers featured in this special issue cover aspects that are critical to an understanding of the design and operation of the Twin Peaks model and its implementation in jurisdictions such as Australia and South Africa. The first paper, “Australia’s Trek Towards Twin Peaks: Comparisons with South Africa”, traces the evolution of the Twin Peaks model in Australia and draws comparisons with the model that is being implemented in South Africa. It also highlights ongoing areas of debate in Australia and what the debate reveals about the operation and challenges of the Twin Peaks model generally. Drawing on the experience in Australia, the paper identifies aspects that are of critical importance to the Twin Peaks model, including effective coordination between the regulators, appropriate governance, operational independence and sufficient funding to enable each financial regulator to achieve its regulatory mandates.

'“Twin Peaks in South Africa: a new role for the central bank”, provides an overview of the South African Twin Peaks model and points out its unique features. Focusing on the role of the SARB, the paper suggests that the new legislation sets out a comprehensive legal framework for the implementation of the model and creates certainty in relation to the SARB’s financial stability mandate and the mandates of the PA and the FSCA. There are, however, challenges that may arise during the implementation of the Twin Peaks model. The challenges include tensions between the various mandates and inconsistencies between regulatory cultures. The paper concludes by suggesting that South Africa can learn from the experience of other Twin Peaks jurisdictions such as Australia and the Netherlands and that the effective implementation of the model requires a pro-active approach on the part of the regulators in terms of co-operation and collaboration.

“Retail Market Conduct Regulation in South Africa under Twin Peaks”, examines the retail market regulatory reforms that are underway as part of the implementation of the Twin Peaks regulatory model in South Africa. The paper identifies the various normative goals that underpin the reforms, including the development priorities of the South African government, and highlights the importance of strengthening consumer protection and increasing financial inclusion. These goals are particularly important in South Africa given low levels of financial literacy and wealth disparities. The paper also examines the critical question of regulator accountability and the advantages of establishing a board to oversee the performance of the regulators – an issue that has been the subject of recent debate in Australia. The paper concludes that South Africa is well-advanced in its trek towards Twin Peaks.

“A Credit Lens: implementing Twin Peaks”, develops the retail theme of the third paper by focusing on the issues of consumer credit. Viewing the issues through the lens of the “why” and “how” of regulation, the paper examines the similarities and differences between Australia and South Africa in the regulation of consumer credit. One of the key differences is that in Australia, only ASIC has an explicit consumer protection responsibility, whereas in South Africa both the PA and the FSCA will have a consumer protection mandate and, in addition, the National Credit Regulator will have consumer protection responsibilities. The paper also considers related issues that are of critical importance, including access to credit, various challenges that may arise during the staged implementation of the model in South Africa and coordination and accountability. Drawing on the experience in Australia, the paper concludes that regulatory culture will be key to the successful implementation of the Twin Peaks model in South Africa.

Together, these four papers offer insights into the Twin Peaks model as it has been adopted in Australia and other jurisdictions and the issues and challenges that are of critical relevance to the implementation of the model. It is hoped that these papers will be of interest and use to South Africa as it implements its own model of Twin Peaks.

Notes

1 M van Hengel, P Hilbers and D Schoenmaker, “Experiences with the Dutch Twin-peaks model: Lessons for Europe” in Haan Kellermann and Vries (eds), Financial Supervision in the 21st Century (2013), 188.

2 See Department of Treasury, Blueprint for a Modernized Financial Regulatory Structure (2008), 13–4, 142–3.

3 Some commentators refer to the sectoral or operational model as a functional approach, under which each type of business is ‘overseen by a separate, “functional” regulator’. See Group of Thirty, The Structure of Financial Supervision – Approaches and Challenges in a Global Marketplace (6 October 2008).

4 See D Llewellyn, “Institutional Structure of Financial Regulation and Supervision: The Basic Rules”, Paper presented at a World Bank seminar Aligning Supervisory Structures with Country Needs, Washington DC, 6 and 7 June 2006, 26 (2006).

5 Ibid, 23.

6 Ibid, 27.

7 House of Commons, Treasury Committee, Financial Regulation: a preliminary consideration of the Government's proposals, Seventh Report of Session 2010–11 (Volume 1), [83].

8 Ibid.

9 Financial Stability Board, Peer Review of the United Kingdom. Report (2013), 7–8.

10 JCFSB, Report, together with formal minutes and appendices, HL Paper 236, HC 1447, [285].

11 See New Zealand Treasury, Financial Sector Regulatory Agencies – Regulatory Impact Statement (2010), http://www.treasury.govt.nz/publications/informationreleases/ris/pdfs/ris-med-fsra-sep10.pdf/view, accessed on 13 November 2017.

12 National Treasury, Republic of South Africa, ‘A safer financial sector to serve South Africa better’ (policy paper, 23 February 2011), available at http://www.treasury.gov.za/twinpeaks/20131211%20-%20Item%202%20A%20safer%20financial%20sector%20to%20serve%20South%20Africa%20better.pdf, accessed on 13 November 2017.

13 In December 2014, the National Treasury published ‘Treating Customers Fairly in the Financial Sector: A Draft Market Conduct Policy Framework for South Africa’. This document outlines the implementation of the market conduct framework.

14 On 20 September 2017, the National Treasury published the policy document ‘A Known and Trusted Ombud System for All’ for public comment. This document explored the options for reform to the Ombuds, including ‘establishing a single statutory ombud scheme’.

15 ‘Twin Peaks legislation expected to reach Parly in May’ (online) South African Government News Agency (25 November 2014) http://www.sanews.gov.za/south-africa/twin-peaks-legislation-expected-reach-parly-may, accessed on 13 November 2017.