Professional Documents
Culture Documents
2000
FINANCIAL REGULATION
IN SOUTH AFRICA
Financial Regulation
in South Africa
by
ISBN 1 919835 10 5
Published by:
SA Financial Sector Forum
www.finforum.co.za
P O Box 1148, Rivonia 2128
Fax: +27 (11) 802 3127
e-mail: info@finforum.co.za
Financial regulation is a topic that does not enjoy a widespread or thorough understanding. It is often regarded as
obscure, arcane and yet another level of bureaucracy that has to be endured by the private sector. The importance
of designing and maintaining an efficient and effective system to regulate financial markets, financial institutions
and financial service providers lies at the very core of a nation’s economic wellbeing. The collapse of the banking
system in many Southeast Asian countries during the closing years of the twentieth century and the economic
hardships attendant on these events, are perhaps the most dramatic recent examples of how important the
implementation of efficient and effective financial regulation is.
The financial system in general, and the banking sector in particular, has experienced substantial structural
changes since the 1980s. One of the main challenges for financial regulators has been to keep up with and adapt to
these changes, which are often of an international nature. In South Africa the financial regulatory system has
undergone enormous change during this period, including the transfer of responsibility for banking supervision
from the Department of Finance (now known as the National Treasury) to the South African Reserve Bank in
1987, the establishment of the Financial Services Board in 1989 and the creation of the Policy Board for Financial
Services and Regulation by Act of Parliament in 1993.
An extract from the Mission Statement of the Policy Board reads: “The Board wishes to promote and maintain a
safe and sound financial system which will be fair to investors, effective in supplying financial services to all, well
structured and co-ordinated in terms of financial and regulatory matters.” It is in line with this objective that the
Policy Board has commissioned this report.
The report has the following aims:
• To capture the current “state of the art” of financial regulation in South Africa and the world.
• To catalogue and describe the underlying philosophy, guiding principles, ultimate objectives, intermediate
goals, and targets associated with financial regulation.
• To review experience and trends in local and international regulation.
• To draw conclusions about the effectiveness of current regulation in South Africa and what still has to be done.
I commend the reading of this report to all who wish to, or should, know more about financial regulation.
Obviously, this has been an ambitious project that is unlikely to satisfy everyone. The report contains
conceptual ideas of an exploratory nature and no recommendations should be construed as representing the
final view of the authorities.
Gill Marcus
Chairperson of the Policy Board for Financial Services and Regulation
In all countries, the financial system is more regulated and supervised than are other industries. On systemic and
consumer protection grounds alone, it is almost universally accepted that this should be so. Over time it has
become abundantly clear that regulatory arrangements have a powerful impact on (i) the size, structure and
efficiency of a financial system; (ii) the business operations of financial institutions and markets; and (iii)
competitive conditions both overall and between subsectors of the system. Depending upon how the objectives of
regulation are defined, and how efficiently regulatory arrangements are related to their objectives, the impact of
regulation can be either benign or malignant. Some regulatory structures are more likely to contribute to the
ultimate objectives than others. Accordingly, regulation has the capacity to do great harm, to be inefficient by
imposing unwarranted costs on regulated institutions, and even to be perverse (i.e. to operate counter to the
objectives of regulation).
The skill, therefore, is to seek regulatory institutions, structures and mechanisms that maximise the explicit
objectives of regulation while minimising imposed costs. This also means that effective mechanisms for
supervision and enforcement need to be instituted, as these are as important as formal regulatory requirements in
the overall regulatory regime. Effective regulation cannot secure its objectives in the absence of efficient
supervision and enforcement. The potential costs of regulation have to be viewed in a far broader light than the
actual transactions costs incurred. In particular, the impact on the economy as a whole and the cost imposed on
consumers should be considered.
The devising of effective regulation is comparatively easy when six “ideal conditions” are satisfied:
• Competitive pressures in the financial system are weak;
• the financial system is based on subsets of specialist financial institutions, each conducting a narrow range of
business, so that there is a reasonably precise parallel between function and institution;
• the structure of the financial system and the business operations of financial institutions are reasonably stable;
• the moral suasion of the regulatory agencies is universally accepted;
• the business of financial firms is predominantly domestic in nature; and
• simple and limited objectives of regulation are set.
The more the actual conditions move away from these “ideal conditions”, the more complex and challenging the
regulatory process becomes. For regulation to be effective (in that it contributes to its objectives) as well as cost-
efficient it has to adapt and respond to changes in institutional and market circumstances. The more these change,
the more flexible the regulatory arrangements should be. Conversely, regulation becomes more demanding, and
has to be more adaptable, as the objectives of regulation become more subject to change (more particularly the
balance between systemic stability, efficiency and consumer protection). Moreover, as the competitive
environment in the financial system becomes more intense and less stable, the business practices of financial
institutions and the overall structure of the financial system in turn become increasingly subject to change.
In many countries the financial system in general, and the banking sector in particular, are passing through a
period of substantial structural change. The system is subjected to the combined impact of internal competition,
global competitive pressures, changes in regulation, new technology and the fast-evolving strategic objectives of
financial institutions and their existing and potential competitors. The past two decades resulted in major
diversifications (e.g. under the pressure of deregulation and competition), and there was a decisive shift towards
the emergence of financial conglomerates. Above all, the competitive environment intensified markedly as banking
and other sectors of the financial system faced more inter-sector competition, increased competition from a more
innovative capital market, and global competitive pressures.
The task group of the Policy Board for Financial Services and Regulation
Johannesburg: August 2000
INDEX 189
1
Because of insufficient and credible information or because the
quality is revealed only after the lapse of time.
3 4
As determined by their own internal risk models. Financial crises are discussed in Chapter 5.
Objectives
(the ultimate “high-level” objectives the authorities are
attempting to achieve through the regulatory strategy)
Regulatory
intermediate goals
liquidity
fairness
schemes
neutrality
disclosure
Proper risk
retail funds
assessment
Competitive
Integrity and
Competence
Protection of
infrastructure
infrastructure
Fit and proper
Access to retail
competitiveness
competitiveness
market exposures
Acceptable cross-
Transparency and
Proper institutional
Competitive market
Retail compensation
currency mismatches
Securities markets as
Regulatory regime and
its instruments
alternative to intermediation
1. Official rules and regulations
1.1 Entry and standards constraints X X X X X X X X X X X X X
6. Corporate governance X X X X X X X X X
7. Discipline/accountability of
X X X
regulators
43
some optimal combination of instruments that stability (e.g. by harmonising regulation and by
achieves the desired combination of targets. The value introducing capital-adequacy rules or solvency
(or intensity) of each instrument is aimed not only at regimes), it may nonetheless fail on one or more of the
having positive effects on particular targets, but may following grounds:
also be used to neutralise the negative effects of other • Technological improvements and financial
instruments. This analysis indicates therefore that, if innovation may result in recourse to increasingly
each of the regulatory objectives is to be secured, a more regulations to address a specific problem
multi-instrument approach is required: i.e. an (what might be termed “regulatory escalation”).
optimising approach designed to achieve satisfactory What may start as a small issue, over time, may
levels of competition, efficiency and safety. No single becomes a highly costly exercise which becomes
instrument will suffice, and the more one objective is totally out of proportion to the initial problem.
sought through a particular instrument, the greater will • Regulation may create monopoly problems in its
be the demand on other instruments to offset the own right (e.g. the imposition of new and/or more
potentially negative effects upon other regulatory stringent entry requirements).
objectives. Therefore a co-ordination of the various • Regulation may create a moral hazard (e.g. bank
objectives and instruments is required. An example deposit insurance).
can be found in arrangements made for the protection • Regulation may result in inefficiencies, particularly
of the consumer. One way of dealing with potential when the restrictions are not related to risk. For
conflicts of interest that may work against the interest instance, capital requirements that are not
of the consumer is regulation that restricts a financial accurately based upon actuarial risks may impact
firm’s range of allowable business. If such regulation adversely on an institution’s efficiency.
is eased, it may be necessary to resort to other • Regulation may deteriorate into over-regulation,
measures to limit the potential for conflicts of interest, which will reduce consumers’ access to cheaper
such as recourse to dedicated capital, Chinese walls, products owing to the cost of excessive regulation.
rules of business conduct, compliance officers and • Regulation may result in welfare losses as a
disclosure rules. consequence of rent-seeking efforts. Accordingly,
As regulatory instruments generally constrain the interest groups may be induced to lobby strongly to
activities of market participants (and thus may harm maintain their economic rents.
innovation and efficiency), the ideal should be to use • Regulatory capture may occur whereby certain
the minimum number of instruments to obtain the parties come to exploit opportunities to manipulate
maximum effect on the intermediate goals. Regulatory
constraints are justified in that they aim to reduce 1
Although in the short-run systemic stability can often be
market failure: i.e. asymmetric information (resulting enhanced by more stringent controls, in the medium to long term
in, for instance, insider trading), monopoly powers such controls may endanger the stability of the financial system.
From an analytical point of view a clear distinction should be
(often a result of high entry and/or exit barriers), and drawn between the stability of the financial system and that of an
externalities (e.g. systemic risks1). Although the individual company. In competitive markets, firms in crisis may
be a symptom of “creative destruction”, as the emergence of new
response of the regulators to market failure may be undertakings logically requires the demise of others which may
successful in extracting more information from the have become obsolete. The emergence of new products, new
firms and even whole new industries goes hand-in-hand with the
market (e.g. by way of transparency arrangements, disappearance of outdated products, the often brutal elimination
establishing formalised markets, imposing adequate of whole areas of activity and also, naturally, of individual firms.
The disappearance of some production units in such a manner
disclosures or conduct of business rules), in curtailing may lead to a higher level of efficiency and overall systemic
monopoly powers (e.g. by setting rules and outlawing stability, as the remaining firms adjust to a new efficiency
standard and the new dynamic market conditions. Ultimately
restrictive trade practices) or in promoting systemic there is a natural conflict between creativity and a peaceful life.
Table 4.12: Principles for the conduct of investment business (in the UK)
• Integrity. A firm should observe high standards of integrity and fair dealing in the conduct of its business.
• Skill, care and diligence. A firm should act with due skill, care and diligence in the conduct of its business.
• Market practice. A firm should observe high standards of market conduct. It should also, to the extent
endorsed for the purpose of this principle, comply with any code or standard as in force from time to time and
as applied to the firm either according to its terms or by rulings made under it.
• Information about customers. A firm should seek from customers it advises or for whom it exercises
discretion any information about their circumstances and investment objectives which might reasonably be
expected to be relevant in enabling it to fulfil its responsibilities to them.
• Information for customers. A firm should take reasonable steps to give a customer it advises, in a
comprehensible and timely way, any information needed to enable him to make a balanced and informed
decision. A firm should similarly be ready to provide a customer with a full and fair account of the fulfilment of
its responsibilities to him.
• Conflicts of interest. A firm should either avoid any conflict of interest arising or, where conflicts arise, should
ensure fair treatment to all its customers by disclosure, internal rules of confidentiality, declining to act, or
otherwise. A firm should not unfairly place its interest above those of its customers and, where a properly
informed customer would reasonably expect that the firm would place his interests above its own, the firm
should live up to that expectation.
• Customer assets. Where a firm has control of or is otherwise responsible for assets belonging to a customer
which it is required to safeguard, it should arrange proper protection for them, by way of segregation and
identification of those assets or otherwise, in accordance with the responsibility it has accepted.
• Financial resources. A firm should ensure that it maintains adequate financial resources to meet its
investment business commitments and to withstand the risk to which its business is subject.
• Internal organisation. A firm should organise and control its internal affairs in a responsible manner, keeping
proper records, and where the firm employs staff or is responsible for the conduct of investment business by
others, should have adequate arrangements to ensure that they are suitable, adequately trained and properly
supervised and that it has well-defined compliance procedures.
• Relations with regulators. A firm should deal with its regulators in an open and co-operative manner and
keep the regulator promptly informed of anything concerning the firm which might reasonably be expected to be
disclosed to it.
* There usually are sufficient laws to prevent or to punish gross violations of conduct by the agencies, such as providing a
favourable rating in exchange for a secret payment.
Regulatory
intermediate goals
liquidity
fairness
schemes
neutrality
disclosure
Proper risk
retail funds
assessment
Competitive
Integrity and
Competence
Protection of
infrastructure
infrastructure
Fit and proper
Access to retail
Sufficient market
financial services
market exposures
Acceptable cross-
Transparency and
Proper institutional
Competitive market
Retail compensation
currency mismatches
Securities markets as
Regulatory regime and
its instruments
alternative to intermediation
1. Official rules and regulations
1.1 Entry and standards constraints + – + + + + + + + +
6. Corporate governance + + + + + + + + +
7. Discipline/accountability of
+ + +
regulators
77
4.1 Deregulation instinct”), which in turn results in “overshooting” a
Deregulation has created an environment of greater longer-run equilibrium position.
freedom. Firstly, controls on prices, quantities and Deregulation is necessary to create scope for
cross-border capital movements have been lessened or financial innovation (see Table 4.24) and to
even removed in full. Secondly, as a result of accommodate the increasing pressures emanating from
institutional despecialisation and the opening of globalisation. Today the deregulation of financial
domestic markets to foreign competition, financial markets seems unavoidable, although it should be
enterprises have been given much greater freedom to handled with care. Cognisance should be taken of the
choose lines of business, location, area of operation important policy lessons learned over the past few
and financial structures. years in respect of the deregulation process:
Deregulation intensifies the competitive • Deregulation should proceed rapidly but at a pace
environment, particularly in the early stages of major that gives market participants sufficient time to
adjustments to portfolio composition. It may lead to a prepare themselves for the new environment in
redistribution of income from the suppliers to the users terms of internal controls, restructuring and
of financial services and thus increase the fragility of adjustments to their business strategies, training of
the financial system. Moreover, the oligopolistic staff and so on.
structure of the financial industry frequently • A proper balance should be struck between
pressurises firms into moving together (the “herd deregulation in different segments of f i n a n c i a l
MACROECONOMIC FACTORS
Capital flight 2
Dutch disease 4
Asset bubble 7
Recession 16
Terms of trade drop 20
MICROECONOMIC FACTORS
Weak judiciary 2
Fraud 6
Lending to state enterprises 6
Connected lending 9
Political interference in lending 11
Deficient bank m anagement 20
Poor supervision & regulation 26
0 5 10 15 20 25 30
1. As indicated above, bank insolvencies are at times due to bad luck (e.g. capital flight or bank runs), or bad shocks (e.g. recession or adverse
terms of trade).
2. Source: G.Caprio and D.Klingebiel "Bank Insolvency: Bad luck, Bad policy, or Bad banking" in M. Bruno and B Pleskovic (eds), Annual World
Bank Conference
Ghana, 1982-89
United States, 1984-91
Sweden, 1991-94
Russian Fed., 1998
Norway, 1987-93
Czech Rep., 1989-91
Brazil, 1994-96
Philippines, 1983-87
Malaysia, 1997-present
Spain, 1977-85
Mexico, 1995-present
Japan, 1990s
Venezuela, 1994-97
Cote d'Ivoire, 1988-91
Rep. of Korea, 1997-present
Thailand, 1997-present
Chile, 1981-83
China, 1990s
Indonesia, 1997-present
Argentina, 1980-82
0 5 10 15 20 25 30 35 40 45 50 55 60
Table 5.1: Advantages and disadvantages of consolidated regulation and separate regulation
Advantages Disadvantages
Consolidated regulation
• Addresses consistently the concerns of contagion in • May be burdensome and even create competitive
a financial conglomerate disadvantages for otherwise unregulated entities
• Fully harmonises the approaches of consolidated • Requires extensive co-ordination and even
supervision and consolidated accounting modification of responsibilities among regulatory
• Enhances transparency and public disclosure agencies
• Addresses the risk characteristics of the institution
as a whole
Separate regulation
• Harmonises fully with the functional approach to • Results in transparency problems
financial regulation, and therefore enhances the • Has difficulty in detecting problems in overall
efficiency of separate financial entities organisational and management structures
• Supports explicitly the autonomy concerns of • Addresses contagion problems in a fragmented way
different regulated functional entities
• Lessens co-ordination and authority concerns
among regulatory agencies
3.4 Promoting monetary and 3.4.1 The conventional view that central
financial stability banks should limit themselves to
Recognising that regulatory provisions can have monetary stability only
systemic implications with macroeconomic effects There are strong arguments why central banks should
raises two questions:
• Should central banks have a role in designing
19
Credit risk causes liquidity to disappear, in turn generating price
movements significant enough to have effects on perceptions of
regulatory regimes? market risk.
Box 5.1: The political dimension of transferring bank supervision from the central bank
Transferring bank supervision outside the central bank has an important political dimension. For one, it implies a
lower institutional barrier between the politicians and the financial regulators. A balance of power as a counter to
populist day-to-day party politics demands a separation of powers*. For instance, in the South African context, the
State President appoints the governors of the central bank on a fixed five-year contract, while the independence of
the central bank is enshrined in the Constitution. By contrast, the National Treasury is a straightforward
government department headed by a political appointee (i.e. the Minister of Finance), who may leave his office at
any time (e.g. after a Cabinet reshuffle). Further, the central bank is of great importance in any country because of
the legal right to create money. One of the important issues arising from this right is whether this function should
fall under the ultimate control of the executive branch of government or whether parliament should leave this
responsibility to an independent, autonomous institution run by unelected people. The traditional argument in
favour of an independent central bank is that the power to spend money should be separated from the power to
create money. Numerous episodes in the world’s economic history testify to a government’s potential abuse of its
power to create money and a resultant increase in inflation (e.g. many governments have given way to the
temptation to reduce interest rates ahead of elections). Central bankers normally operate on a longer-term time
scale than politicians and therefore do not face the same temptation to relax policy to achieve short-term
objectives (in fact, the Governor of the SA Reserve Bank has suggested that increasing the governors’ terms of
tenure from the five-year political cycle would improve the autonomy of the Bank). By delegating decisions about
interest rates and other monetary matters to such an independent institution, with a clearly defined mandate,
society can hope to achieve a better inflation outcome over the longer term.
Generally in old established democracies, where effectively the “middle-class” rules, and where there is a
distinct separation of powers, the lowering of the political barriers may be less problematic – particularly in a
federal constitutional set-up as found in the US and now increasingly in the EU – than in developing countries
where the young democracies effectively represent the poor and often the unemployed.
Accordingly, the envisaged efficiency gains of a one-regulator structure in industrial countries may well turn out
to be inappropriate for developing countries, as short-term political opportunism may take its toll (note for instance
the recent experiences in Indonesia and Zimbabwe). Although private bankers may prefer (on a basis of principle)
that the structure of their regulators should mirror as closely as possible their own organisational structures, a
trade-off has to be made between the economic and political interests of society. These country-specific dilemmas
are one of the reasons that the one-regulator structure of the UK cannot simply be copied by developing countries
such as South Africa. In fact, not even the UK is of the opinion that their current regulatory arrangement of a
mega-regulator is an ideal export product.
________________________________
* For instance, the trias politica and upper and lower houses in parliament are just a few of the instruments used to ensure a
balance of power in the state and go back at least until the times of Montesquieu.
This chapter endeavours to describe the current 1.2 The regulatory regime and structure
structural framework of financial regulation in South for financial instruments
Africa. Any financial system consists of three major Since financial innovation enhances competition, the
components: (i) financial instruments; (ii) markets in regulatory authorities are reluctant to interfere
which these instruments trade; and (iii) market unnecessarily in the creation of new instruments, some
participants1. This analysis is divided into similar of which can be used to mitigate risk. The issuing of
sections. Section 1 examines the current regulation of and trading in many financial instruments are therefore
financial instruments. Section 2 outlines the regulation subjected by and large to market disciplines only. For
of financial markets and Section 3 analyses the instance, swap contracts – despite their large amounts
regulation of financial market participants. In each and often sophisticated nature – are unconstrained in
section the regulatory regime is highlighted by means terms of official regulation2 in South Africa.
of a regulatory matrix. In contrast, the authorities do regulate the issue of
company shares and debt instruments, as well as the
1. Regulation of financial derivatives on these instruments. For instance, in the
instruments interests of systemic stability the authorities prescribe
minimum standard requirements for the issuing of
1.1 The definition and nature of money- and capital-market instruments and/or the way
financial instruments they should be traded.
Ultimately any financial instrument can be broken The issuing of money- and capital-market instruments
down into cash (money) and/or options. Therefore is regulated by general legislation, specific prescriptive
cash and options provide the basic building blocks for legislation and/or specific enabling legislation. Those
“financial engineering”, which facilitates the money- and capital-market instruments can be created
continuous creation of new financial instruments. by a wide variety of issuers and are usually regulated in
Simultaneously, competition ensures the demise of terms of general legislation. For instance, the Bills of
commercially unviable instruments. In fact, not all Exchange Act and the Companies Act stipulate in detail
newly created financial instruments survive in the the issuing and processing requirements of bankers’
long run, as some new instruments are often not acceptances, trade bills, promissory notes, corporate
liquid enough, too complicated, too difficult to debentures and equities.
capture in existing management control systems, or In cases where the issuer is established in terms of
simply have fulfilled their tasks. Diagram 6.1 gives specific prescriptive legislation (e.g. in the case of a
an overview of major financial instruments in the spot public business enterprise) such legislation usually
and derivative markets. contains stipulations about the issuing requirements
1 2
Such as lenders, borrowers, financial intermediaries, brokers, The market may however constrain trading operations by
fund managers, financial advisers and trustees. applying self-imposed regulation.
Cash Options
Financial instruments
* “Spot” settlement in South Africa is currently 2 days (T+2) in the currency market, 3 days (T+3) in the bond market and up to 7 days in the equity market.
Regulatory
intermediate goals
liquidity
fairness
schemes
neutrality
disclosure
Proper risk
retail funds
assessment
Competitive
Integrity and
Competence
Protection of
infrastructure
infrastructure
Fit and proper
Access to retail
competitiveness
competitiveness
market exposures
Acceptable cross-
Transparency and
Proper institutional
Competitive market
Retail compensation
currency mismatches
Securities markets as
Regulatory regime and
its instruments
alternative to intermediation
1. Official rules and regulations
1.1 Entry and standards constraints X X X X
6. Corporate governance
7. Discipline/accountability of
regulators
119
specific financial instrument, it can usually be defined bonds obtain their statutory liquid-asset status.
in terms of the instrument being traded. For instance, However, most dealers, both in South Africa and
the bond market can be defined as a place or facility8 abroad, define the money market as a market that
where trade in bonds takes place. However, the trades in instruments with a maximum tenor of only
grouping of different types of financial instruments into one year.
a single financial market usually results in problems of Apart from the issue of the tenor of money-market
definition. A few examples illustrate this point. instruments, there are some additional problems of
The money market is usually defined as the spot definition. The distinction between the spot market
market for short-term “securities”9. But what is short and the forward market is unclear at times. It is
term? For some dealers the demarcation between the normal practice to consider some repurchase
money market and bond market in South Africa is agreements (e.g. valid for a few days only) as
three years because, they argue, it is only then that money-market instruments, despite the fact that a
repurchase agreement is in essence a forward
8
It used to be a trading floor, but today most financial markets are agreement and therefore belongs to the forward
electronic. Bond markets have generally been the last to embrace market. Even if participants aim at spot settlement in
electronic trading technology, with corporate bond markets being
last of all. the money market, this may not always be possible
9
Securities may be notional or fictitious. because of problems related to market practices,
Legislation in respect of
financial instruments
Spot market
14 15
In the formal futures markets, cash settlement takes place daily For example, a short spot position by way of a long put and short
on a marked-to-market basis (i.e. the “margin call”) until the call, both at the same strike price.
contract finally matures at some future date. 16
This is the crux of the Arrow/Debreu contingent claim analysis.
Derivative market
Listed option contracts Futures contracts Forward contracts OTC option contracts
yyyyyyyy
Derivative market instruments in the narrow sense*
Options/futures
Currencies on e.g. the rand
exchange rate
Options/futures
Equities
on equities
Options/futures
Debt instruments
on bonds
21 22
In BESA customer orders are not necessarily routed to the Today, nearly a third of all retail orders placed for equities in the
primary dealers (market makers) as a matter of routine, but are US are routed through the Internet. In essence the Internet is
executed in the market if they can be. If not, then the primary merely a new medium of communication. Orders placed through
dealers are requested to quote. Primary dealers are not obliged to the Internet are generally funnelled into an order/time priority
display continuous doubles (buy and sell quotes) to the market, engine, which is linked via the brokerage firm directly to an
but have to quote on request. In this respect they are not true exchange’s trading system. Therefore the Internet interface can be
market makers. seen as a “funnel” channelling trades into the regulated markets.
23
Today, on the JSE’s ATS (i.e. the JSE Electronic Trading system 2.5.3 Trading systems of securities markets
or JET) price and quantity are fixed prior to the order being
submitted, whereas in the former “open outcry” system, only the Irrespective of whether a market is order- or quote-
price was fixed. driven, it can employ various trading modes to effect
24
On the JSE orders are now electronically matched and executed
on the JET system.
transactions. The following major trading systems can be
27 28
This can be overcome by allowing “report only” trades through The South African playing field is not very level – e.g. SA
the ATS. This is not a problem with the order-driven mechanism companies can only list overseas with Ministerial approval, whereas
(as used, for instance, by the JSE). overseas companies are free of any form of exchange control.
Regulatory
intermediate goals
liquidity
fairness
schemes
neutrality
disclosure
Proper risk
retail funds
assessment
Competitive
Integrity and
Competence
Protection of
infrastructure
infrastructure
Fit and proper
Access to retail
competitiveness
competitiveness
Sufficient market
market exposures
Acceptable cross-
Transparency and
Proper institutional
Competitive market
Retail compensation
currency mismatches
Securities markets as
Regulatory regime and
its instruments
alternative to intermediation
1. Official rules and regulations
1.1 Entry and standards constraints X X X X X X X X X X
6. Corporate governance
7. Discipline/accountability of
regulators
135
sponsorship. Since the Big Bang on the JSE in 1995, increases local liquidity, but also increases foreign
the traditional constraints on ownership and pricing competition.32 Moreover, there is keen competition
have fallen away on the JSE, and the aim of the between the underlying market (e.g. the equities quoted
authorities is now to consolidate the SECA with the on the JSE) and the derivative market (i.e. options and
FMCA into a new act (probably named the Investment futures on those equities or indices based on them on
Services Act). SAFEX). It is primarily the forces of competition that
The entry and standards constraints for an exchange lead to innovation and technological enhancements.
largely centre on the licensing requirements, risk-
management systems and guarantee or fidelity funds. 2.6.3 The structure of the market regulators
The functional constraints are that the securities traded The regulatory structure is unique for every market
on an exchange may only be listed securities (e.g. not and every country, as no two countries have identical
the shares of a private company – “(Pty) Ltd”). legislative structures. Different circumstances often
Moreover, the rules and regulations of the exchange demand different structures in order to ensure effective
stipulate in detail which securities may be traded on the and cost-efficient regulation. In principle there are
exchange. The jurisdictional constraints limit three basic models:
exchanges’ operations to South Africa (so far as they • A single regulatory authority for each basic market,
apply to listed securities30), although efforts are being in which case one regulatory authority regulates all
made to extend this to the Southern African relevant activity in one basic market (e.g. in the
Development Community (SADC) region. The currencies markets).
operational constraints are not only the familiar • More than one specialised regulatory authority for
prudential requirements and code-of-conduct activities within basic markets, implying that parts
requirements (such as appropriate capital adequacy and of one basic market are regulated by various
the avoidance of conflicts of interest), but also contain specialist regulatory authorities. This structure is
conditions that trading must be limited to exchange found in South Africa where spot and derivative
members only. Official monitoring and supervision are instruments in the same basic market (e.g. equities
undertaken by both the Financial Services Board and market) are supervised by different self-regulatory
the inspectorates of the exchanges and is aimed at organisations.
enhancing the institutional infrastructure, and at • A separate entity for the three basic functions33 of an
avoiding insider trading and fraud. exchange: (i) execution; (ii) clearing and risk
Despite all these formal regulations, market management; and (iii) settlement and delivery. In
discipline remains crucial to ensure effective and cost- terms of such a model the exchanges will
efficient trading on exchanges. Local exchanges have concentrate exclusively on their execution functions,
to compete successfully with foreign exchanges such as while the clearing of all their trades will be done by a
the London Stock Exchange to remain in business.
Remote trading31 by foreign members of the exchange 32
Remote trading currently occurs at SAFEX, and at some future
date this may also happen at the BESA or the JSE. In the South
30 African bond market, foreigners participate in one of two ways:
The exchanges in South Africa are free to make their systems and
services available to the OTC markets or to markets offshore, either via direct trading with member firms (known as non-
which activities would fall outside the ambit of their financial resident trading) or directly among themselves (e.g. two foreign-
market licences and constitute a separate line of business. A based entities) in the OTC market. This turnover represents some
problem experienced with exchange rationalisation in South 35% of the exchange’s overall annual turnover. Remote
Africa was due to the mix of retail and wholesale business – membership of a local exchange will have a significant impact,
SAFEX and BESA are wholesale and employ clearing or particularly in the bond market, as the “foreign” primary dealers
settlement members whereas the JSE does not. have invested significantly in setting-up local operations to
31
Remote trading means that foreign participants can also use the comply with National Treasury requirements.
33
exchange facilities by means of electronic networks. Also referred to in the market as “platforms”.
Equities x
Bonds x
Futures x
Options on futures x
Minister of Finance
* The diagram depicts relationships in terms of the Acts and not organisations
money money
Banks
indirect primary
securities Institutional investors securities
money money
Investment firms
primary primary
securities Traders securities
money
Brokers
(direct financing)
primary securities
44 45
JSE stockbrokers are not “pure” brokers as they can trade with The Nel Commission of Inquiry, Nov. 1997, p.104.
clients or among themselves for own account. Most trades with 46
Asymmetrical information problems are one of the major reasons
clients are, however, on an agency basis because inter alia that small investors do not always fully understand the financial
commission cannot be charged on trades with clients on a products they are buying.
principal basis.
Financial markets
BESA
JSE
SAFEX
Banks
Ultimate borrowers
Insurers
Investment firms* and
Fund managers
ultimate lenders
Investment firms
* Investment firms that are members of the JSE may be subsidiaries of other financial institutions, e.g. banks.
3.2 The regulatory regime and structure subdivided again. Banks can be classified as
for financial market participants commercial banks, merchant banks and mutual banks;
Usually financial institutions are functionally divided insurers can provide long-term (life assurance) or
into three broad classes: banks, insurers and short–term insurance; and investment firms can be split
investment firms. The essence of banks is that the cost into fund managers, securities traders and brokers.
of their liabilities is fairly certain, but that the return on This section highlights some of the regulatory
their (illiquid) assets is uncertain (mainly owing to the differences between these various types of institutions,
credit risk on their unmarketable loans); insurers have with the emphasis on private-sector financial
mutatis mutandis uncertain liabilities (i.e. as reflected institutions. The contrast between public-sector
in the actuarial risk) and certain (mainly marketable) financial institutions and their private sector equivalents
assets; whereas investment firms have certain is stark but relatively simple. For all practical purposes,
(marketable) assets and also liabilities (i.e. they are financial institutions in the public sector are exempted
exposed predominantly to market risks). in full from the usual statutory requirements (as
These three classes of financial institutions can be imposed on private-sector institutions), as their risk
Regulatory
intermediate goals
liquidity
fairness
schemes
neutrality
disclosure
Proper risk
retail funds
assessment
Competitive
Integrity and
Competence
Protection of
infrastructure
infrastructure
Fit and proper
Access to retail
competitiveness
competitiveness
market exposures
Acceptable cross-
Transparency and
Proper institutional
Competitive market
Retail compensation
currency mismatches
Securities markets as
Regulatory regime and
its instruments
alternative to intermediation
1. Official rules and regulations
1.1 Entry and standards constraints X X X X X X X X X
1.2 Ownership constraints X
1.3 Functional activity constraints X X X
1.4 Jurisdictional constraints X X
1.5 Pricing constraints X
1.6 Operational constraints X X X X X X X X X X
6. Corporate governance X X X X X X X X
7. Discipline/accountability of
X X X
regulators
147
of long-term policies (e.g. life-assurance policies, requirement (namely the elimination of currency risk),
endowment policies and retirement annuities) – with a but is used simultaneously as a tool to avoid unwanted
strict demarcation being applied between such capital outflows.
assurance business and other business of a long-term Exchange control stipulates that only banks can be
assurer. Moreover, the Registrar of Insurers may authorised dealers in foreign exchange, and that
impose restrictions on the business of issuing policies foreign-exchange brokers are not permitted to
and may prohibit the removal of certain assets from conduct any business other than foreign-exchange
the country. Accordingly, insurers may only issue broking. The Banks Act restricts the business of
specific financial instruments, such as endowment deposit taking to South Africa, with special
policies, whereas only banks may create NCDs. provisions in place that provide scope for the
However, an endowment policy of, say, one day establishment of subsidiaries outside South Africa as
becomes de facto a deposit, and a one-year fixed well as for the establishment of representative offices
deposit can be simulated perfectly by option contracts of foreign banks inside the country.
in the derivative markets. In essence, financial Likewise, insurers are subjected to exchange control,
engineering is undermining this functional particularly in respect of cross-border insurance
demarcation, a process aggravated by the development premiums and benefit payments as well as their
of multi-product financial conglomerates. offshore investment holdings. Moreover, the prudential
Likewise the Short-term Insurance Act limits the requirements of the Insurance Act and the Pension
business of a short-term insurer to short-term Funds Act stipulate a covered domestic position of 85%
business, i.e. the issuing of indemnity-type insurance for such institutions.
policies. And again, the Registrar of Insurance may The stated policy of the Minister of Finance is to relax
impose additional restrictions on the business of exchange control regulations gradually in the years to
issuing policies. In a similar way the activities of come. Accordingly, the covered domestic position
reinsurers, medical aid schemes, pension funds, requirements may well be reduced further in future.
friendly societies, fund managers, unit trust schemes, Pricing constraints
participation mortgage bond schemes and trustees are The pricing of financial products and services is, with
functionally constrained. only a few exceptions, unconstrained in South Africa.
Finally, in terms of the National Payment System Act, The exceptions are the Usury Act, which limits the
only banks or their agents may process payment financial charge rates to a maximum of 25% p.a.
instructions and only banks may settle payment generally, or ten times the prime rate for specific
obligations across accounts held at the SA Reserve Bank. industries such as microlenders, as well as the
The aim of this constraint is to achieve a high level of commission fees of insurance brokers.
payment system integrity and reduce systemic risk. As banks’ lending rates are usually well below the
Jurisdictional constraints ceiling rate set by the Usury Act, this Act applies
This field of legislation is dominated by the Currency mainly to microlenders and related types of non-bank
and Exchange Act, which subjects any cross-border business. It is expected that the commissions payable
financial transactions to exchange controls. The to insurance brokers will be fully deregulated during
ultimate aim of exchange control is to protect the 2001. A bill in this respect is likely to go before
country’s currency, and by implication its foreign- Parliament towards the end of 2000.
exchange reserves. The requirement that certain Operational constraints
financial institutions must maintain a covered position Operational constraints usually fall into two major
(i.e. local currency liabilities have to be covered with categories: prudential requirements and market
local currency assets) is primarily a prudential business conduct requirements. Once again, these
Diagram 6.8: Operational constraints placed on market participants (expected structure in 2001)
Banks
Appeal Boards
* The Office of the Registrar of Financial Institutions encompasses the registrars of all non-bank financial institutions, i.e. the Registrars of: Stock
Exchanges; Financial Markets; Insurers; Pension Funds; Unit Trusts and Friendly Societies.
Responsibilities under the Usury Act lie with the Department of Trade and Industry. Responsibilities under the National Payment System Act lie
with the SA Reserve Bank.
17 19
For banks the Bank Supervision Department of the SA Reserve For details of the principles see the Bank for International
Bank carries this expense. Most securities firms are de facto Settlements’ Website at: http://www.bis.org/publ/bcbs30a.htm
supervised in terms of their capital adequacy by the JSE and not 20
During the 1990s Short- and Long-term Insurance Ombudsmen
by the BESA or SAFEX or even the FSB. were appointed voluntarily by the respective South African
18
Strictly speaking, public education is not an exchange task – not insurance associations, which pay their remuneration and the
even the education of the investing public. administrative expenses.
28 29
A close tie with the local community is extremely important in If a bank is undercapitalised and its shareholders are unwilling to
the South African context because the government cannot always support it in a rights issue, one alternative for the bank would be
ensure law and order in the townships and rural areas. As a to securitise part of its assets (usually mortgage loans and
result, the large banks have hesitated to lend in these areas as the instalment credits) and so reduce the size of its asset book in line
operational risks were considered simply too great. with its available capital.