Everything You Need To Know About The Conduct of Financial Institutions Bill

What is it, why does it exist and why is it vital?

The draft Conduct of Financial Institutions Bill (COFI) was released for public comment in 2018. COFI was drafted in conjunction with the Financial Sector Regulators Act  of 2017 (FSR Act) as fraction of an extensive reform of the South African financial services legal framework. COFI is one of the final steps in the Twin Peaks regulatory reform and represents an umbrella piece of legislation for financial institutions. COFI will replace existing industry-specific conduct regulation such as the Financial Advisory and Intermediary Services Act of 2002 (FAIS), the Collective Investment Schemes Control Act of 2002 (CISCA), and the Short- and Long-Term Insurance Acts, and will be focused on regulating the general market conduct of financial institutions and the objective treatment of customers.

The FSR Act is the first leg of the financial services law reform and has already been implemented. The FSR Act introduced the Twin Peaks regulatory framework, bringing into existence two regulators for the industry. The first regulator is the Prudential Authority (PA) responsible for the prudential regulation of financial institutions, while the second is the Financial Sector Conduct Authority (FSCA) responsible for regulating market conduct. The Twin Peaks regulatory reform is a direct response to the weakness of the financial services regulatory scheme identified by the 2008 Global Financial Crisis, such as the systemic risks of large insurers and inappropriate market conduct practices.

COFI is the second leg of the Twin Peaks reform and seeks to directly address and focus on inappropriate market conduct practices. COFI requires financial institutions to provide consumers with clear information about their services, their fees, and the risks associated with their products. COFI aims to go away from a ‘rules and regulations’ approach (tick box exercise) to a ‘principles and outcomes-based’ approach.

Application of COFI

Which sectors are regulated?

COFI regulates the entire financial services sector including banks, insurers, asset managers, brokers, financial advisors, administrators, pension funds, collective investment schemes, hedge funds, private equity funds, custodians and brokers as well as credit rating agencies in terms of market conduct. In addition, licensed activities under COFI are listed in schedule 1 of the second draft bill and include the provision of a financial product, distribution, financial advice, discretionary investment management, administration, fiduciary or custodian service, payment service, debt collection service, financial market activities and corporate advisory services.

When will COFI be published?

The FSCA submitted the first version of the COFI Bill for public comment in December 2018. After receiving considerable industry feedback, a second version was published for public comment in September 2020. In 2022, the FSCA published a regulation region which referred to a phased approach for the implementation of COFI cognisant of the sweeping changes introduced by it. These phases included a harmonisation project for a number of amendments to pre-existing financial services legislation that is required before COFI can be enacted. It is also anticipated that a third draft of COFI may be released for public comment.

The FSCA has not provided any indication of when the COFI Act would become effective. Instead, the FSCA has indicated that the drafting of the harmonisation frameworks was underway throughout 2022, and consultation on the frameworks should occur during 2023. The FSCA is also considering establishing industry reference groups to serve as consultation and discussion forums for progressing this work.

In the interim, the FSCA will regulate financial institutions using conduct standards.

COFI Requirements

All financial institutions are required to comply with the market conduct requirements under COFI,  including rules relating to the honest promotion of financial services/products, disclosure of information and advertising requirements. This also regulates the design of financial products to accommodate customers’ needs and the provision of financial products/services to the correct target market and in a manner that meets customers’ expectations. Other market conduct principles include that the financial institution cannot impose unreasonable post-sale barriers on customers, in order to allow for the customer to switch to a different service/product provider or to terminate their contract with the financial institution should they choose to. There are also additional obligations imposed on financial institutions in respect of the safeguarding of customers’ assets.

COFI also has a separate chapter that addresses the credit ratings produced by credit rating services agencies, although credit rating agencies are not licensed institutions under COFI but are licensed under the FSR Act.

Certain financial institutions that conduct schedule 1 activities under COFI must be licensed under COFI and comply with the licensing requirements on an ongoing basis. These ongoing requirements under COFI include:

Appointment of qualified and competent representatives who meet the prescribed fit and proper standards; Appointment of key persons who meet the prescribed fit and proper standards; Adherence to governance standards including detailed corporate policies; Remuneration and compensation practices must be reasonable and commensurate to the level of services provided; There must be a conflict of interest policy with proper disclosure to the FSCA; There must be a transformation policy more closely aligned to the achievement of tangible targets; Obligations of sufficient financial resources and operating capital; There are also operational ability requirements such as a fixed address in South Africa, communication and storage facilities;  Reporting and record-keeping obligations; and The requirement to gain financial statements audited or independently reviewed and the appointment of an auditor.

What is the COFI Transition Period?

Schedule 4 outlines the transitional arrangements regarding licensing. COFI will recognise financial institutions that acquire pre-existing licences and there will be a 4-month transition period for licence applications for entities that require a current licence under COFI.

Potential current licence categories under COFI

Although we anticipate a revised third draft for COFI, the second draft of COFI that was published in 2020 has introduced a range of potential current licence categories under COFI:

Lending institutions

The primary regulator of banks in South Africa is the South African Reserve Bank (SARB), which administers the Banks Act of 1990 and COFI, will regulate the market conduct of banks. Other commercial lenders in South Africa are also regulated as credit providers by the National Credit Act of 2005 (NCA). COFI will expand the current lending licensing regime by including lenders who currently are not required to be registered credit providers under the NCA. COFI has introduced a novel licence category of “lending” which is defined as the provision of credit under a lending agreement not regulated in terms of the NCA, essentially outlining that no person may lend, give financial advice in respect of lending or provide general administration services relating to lending, unless issued with a licence under COFI, or appointed as a representative of a financial institution that is appropriately licensed. The COFI Bill introduces current licensing requirements to players in the financial field, especially the “credit to non-retail” lenders.

Corporate Finance

COFI introduces a current licence category for “corporate advisory services” which would essentially apply to investment banking activities, such as arrangement of debt and equity issues, advisory services (in relation to M&A activities), and on- and off-balance sheet financing of transactions, but should exclude any attorneys providing corporate legal support. There also seems to be provision for counter-parties to “opt out” as a category of financial customer under COFI, thereby circumventing the requirement for this licence. However, this licence requirement may gain far-reaching consequences for those operating in the corporate advisory space that acquire never been obligated to be licensed before.

Juristic Representatives

Although this is not a “new” type of licence category per se, it is anticipated that COFI will enact away with the juristic representative licence category, particularly for discretionary asset management. There is also uncertainty as to whether juristic representatives will still be allowed to provide  financial advice. This will therefore require those who were previously licensed as juristic representatives under FAIS to access their own licences under COFI.

Kerry Kopke

Kerry has a BBusSci LLB (Cum Laude) and MCom (Financial Management) and was admitted to the Modern York bar in 2008 and as an attorney in South Africa in 2012. She currently lectures a module in the Economics Analysis of Financial Markets at the University of Cape Town. She has worked as an associate at Davis, Polk & Wardwell LLP in Modern York, at Bowman Gilfillan and at Arthur Cox in Dublin. Kerry also has considerable in-house corporate experience having worked for a number of large asset managers in South Africa. Kerry has extended her scope of work to include with the public.For more information about Caveat Legal, or to contact the team, please visit www.caveatlegal.com

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