This is part 5 of a series of articles that is inspired by legendary author, the late Stephen R Covey, whose bestselling book, The seven habits of highly effective people, impacted millions of people around the world. FSPs will do very well to consider the habits highlighted in these articles. To recap-

The first habit – Defining reality and to be proactive. The reality is that the Conduct of Financial Institutions Act (COFI) is upon us, and it will impact your business. Our advice: Be proactive and start preparing for the next wave of regulatory reform.

The second habit – Seek first to understand, then to be understood 

In the previous articles I highlighted the importance of seeking first to truly understand the fundamentals of COFI before expressing an uninformed opinion and potentially leading your team in the wrong direction. I also mentioned the significance of understanding the purpose or objective of the Act and that COFI does not stand on its own. It must be read with the Financial Sector Regulation Act as the FSR Act created the regulatory foundation for COFI to exist. FSPs should be aware that the principles of Treating Customers Fairly (TCF) will be officially incorporated into the COFI Act. In the previous article the significance of culture took centre stage. This article puts the magnifying glass on understanding more about the meaning, significance, and outcomes of good governance.

Governance

According to the Oxford Business English Dictionary, governance means the activity of controlling a company, organisation, or country. Corporate governance is the means of directing and controlling business corporations. Practically, governance simply refers to the values, policies and processes that help the corporation progress toward its goals, whilst adhering to legislation. Logically for any business to be successful, it needs a “governing body”. In relation to a financial institution, ‘‘governing body’’ is defined in the Financial Sector Regulation (FSR) Act as a person or body of persons, whether elected or not, that manages, controls, formulates the policy and strategy of the financial institution, directs its affairs, or has the authority to exercise the powers and perform the functions of the financial institution. In the context of an FSP, company directors and key persons, as defined in the FSR Act, currently commonly referred to as Key individuals as defined in the FAIS Act, are accountable for Governance. 

An FSP without good governance is like a train without a track. As highlighted in my previous article, Governance is one of the cornerstones of any successful business. Governance is synonymous with the principles published in 2016 in the King IV Report on Corporate Governance™ for South Africa. PwC reported in their summary of the King IV Report that in SA, a hybrid system of corporate governance has developed over time, meaning that some practices of good governance are legislated (for example in the Companies Act, 2008) in parallel with the voluntary King Code™ of governance. However, it is important to note that, if there is a conflict between legislation and the King Code™, the law prevails. In the PWC Report, it is recorded that the King IV Code™ contains principles, practices and governance outcomes that interact as follows:

Sound principles are fundamental to good corporate governance and hold true across all organisations. It is important to note that COFI is also based on a principles-based approach.

Practices are recommended at the level of leading practice. The practices associated with a particular

principle should be applied so that they support and give effect to the aspiration as expressed in that

principle. Practices may be scaled in accordance with proportionality considerations, which is also consistent with the principle of proportionality expressed in COFI.

Governance outcomes are the benefits that organisations could realise if the underlying principles – and therefore, ultimately, good governance – are achieved. PWC assert that these governance outcomes are:

— Ethical culture;

— Good performance;

— Effective control; and

— Legitimacy.

In view of the specific focus on Culture and Governance in the COFI Bill, Key persons/individuals can be sure that they will be required to review their governance strategies and policies when COFI is promulgated. One of the ripple effects of COFI will be an increased focus on accountability and some of the key take-aways from this article are the following good governance principles:

Purpose and strategy

The governing body plays an important role in setting the vision, articulating the purpose and strategies of the FSP, helping everybody in the business to understand these and establishing the plans to implement them.

Culture and ethics

The governing body of the FSP sets the tone for ethical and responsible decision-making throughout the business.

Structure and composition

The governing body must employ the right people, with particular regard to each individual’s background, experience, skills, strengths, and weaknesses. It also needs to understand how the addition of an individual to the group impacts the collective capability and effective functioning of the governing body.

Roles and responsibilities

There should be clarity regarding governing body expectations of executives, the various committees, and the individual roles and responsibilities of executives.

Accountability

It is important that the governing body of the FSP ensures that the following elements are in place: 

– A strategy to create an ethical and treating customers fairly culture;

– A flow of information to the governing body and board that aids proper decision-making; 

– Transparency and accountability to external stakeholders and to employees throughout the FSP; and 

– Safeguarding the integrity of financial statements and other key information.

Risk management

By putting in place an appropriate system of risk oversight and internal controls, the governing body can help increase the likelihood that their FSPs will deliver on their objectives.

Conclusion

Proper governance requires time, thought, planning and effective execution from committed leaders who understand the benefits of aligning every level of an FSP to produce the desired results within the regulatory framework. Good corporate governance ensures an ethical culture, fairness, transparency, and that employees can be held accountable for their actions. I have no doubt that Key persons/individuals will have to review some of their governance policies and processes as COFI approaches.

In a rules-based systems, the regulator writes the “rulebook” and FSPs comply, whereas in the principles-based systems, FSPs are more involved with regulation in the sense they need to document how their decisions are consistent with the outcomes of regulation. This article explains the fundamentals of principles-based market conduct legislation. The opportunities, benefits and risks of principles-based legislation will be highlighted in future articles. 

During a compliance presentation hosted by Compli-Serve in August 2022, Hannelie Hattingh, Senior Specialist Market Conduct Strategy at the Financial Sector Conduct Authority (FSCA) made the following remarks regarding the Conduct of Financial Institutions (COFI) Bill:

“The main aim of the COFI Bill is to introduce the holistic conduct framework for financial institutions, and the intention is that it will apply across all the sectors that we regulate.” According to Hattingh, the emerging regulatory framework encompasses both principles and rules. “There will be a balance between principles and rules,” she explained. “In some instances, rules will be appropriate for a specific market or element that we are regulating but the main aim is for an outcomes- and principles-based approach.”

Source: FAnews (Gareth Stokes)

COFI will therefore be more principles-based market conduct legislation as opposed to FAIS, which is regarded as more rules-based. To be honest, when principles-based and rules-based legislation were first highlighted almost 10 years ago, I had no idea what the real difference was, and I had to do some serious homework on the topics to avoid further embarrassment. I quickly realised that behind all the principles and/or rules, complex reasoning will have to occur before one can truly start making sense of it, and then the complexity needs to be simplified for the benefit of all. This article aims to provide you with a better high-level and simplified understanding of the difference between rules-based and principles-based legislation, starting with a focus on the latter. 

Principles-based legislation

It is always helpful to begin a topic by defining it properly, and once again the Oxford Business English Dictionary offers great assistance as it describes a principle as a law, rule, or theory that something is based on or a general or scientific law that explains how something works or why it happens. 

Essentially, principles-based regulation means moving away from reliance on detailed, prescriptive rules and relying more on high-level, broadly stated principles that set the standards by which FSPs must conduct their business. So, practically, the FSCA, instead of prescribing the actions that FSPs must take, would take a step back and define the outcomes that they require providers to achieve. FSPs and their management will then be free to find the most efficient way of achieving the outcome required. The logic of this strategy is based on the idea that FSPs and their management are better positioned than regulators to determine what policies, processes and actions are required within their businesses to achieve a given regulatory objective.

I firmly believe that volumes of legislation, which is the case with COFI that must be read with the Financial Sector Regulation Act, does not necessarily guarantee regulatory quality or government effectiveness. Intuitive reasoning often leads us to assume a higher importance to legislation that is voluminous, more specific, and with detailed rules that could determine a solution for each problem, but we also know that in practice this is not possible. The quantity of legislation even produces the exact opposite effect and often brings complexity and confusion. In this sense, principled-based legislation is good, because it will offer more flexibility for FSPs to be innovative and simplify compliance within the COFI framework.

Principles-based regulation is a regulatory strategy that allows FSPs to determine how to meet regulatory demands. According to the authors of ‘Principled-based regulation-better regulation’, principles-based regulations are outcome focused regulations that concentrate on the goals and objectives of regulations rather than their processes. Conceptually, principles-based standards are more reliant upon professional judgment of FSP management, and they move away from detailed, prescriptive rules and supervisory actions that instruct FSPs how to manage and operate their business. 

Characteristics of principle-based regulations

Principles have a number of characteristics, which include but are not limited to the following:

– They are drafted in generic terms that contain overarching requirements.

– They express the reason behind the rule but not the rule itself. 

– They have very broad application to a diverse range of circumstances. 

– They contain terminology that are qualitative not quantitative, such as “fair”, “reasonable”, and “suitable”) as opposed to a rule, which may state “…within 7 days.” 

A classic example of a principle-based provision is found in section 2 of the General code of conduct, which states that a provider must at all times render financial services honestly, fairly, with due skill, care, and diligence, and in the interests of clients and the integrity of the financial services industry. 

As illustrated above, principles largely refer to behavioural standards, for example, “integrity”, “skill, care, and diligence” and “reasonable care” with which FSPs conduct and organize their businesses and the fairness with which they treat customers and manage conflicts of interest. 

We are fortunate in the sense that there are many business and legal principles in our industry that have been cemented firmly over the decades. The financial services industry has been around for more than 175 years if one considers that Old Mutual was established in Cape Town in 1845 as South Africa’s first mutual life assurance society. This means that, as we approach the promulgation of COFI, we are the beneficiaries of well-established, sound, and even timeless business and legal principles that have sustained successful FSPs for decades. All we need to do is to identify them, understand them, put them in the right context, apply them and implement them – consistently. 

Opportunity

Fundamentally, this is a form of management-based regulation, which requires that regulated entities (FSPs) engage in their own planning and internal rulemaking efforts aimed at the achievement of specific outcomes, which is sometimes considered to be “performance-based.” Under a management-based regulation, an FSP can choose what actions it will take to achieve the regulatory objective. Principles-based regulation therefore provides the opportunity for FSPs to determine the best way to align business objectives and processes with specified regulatory outcomes. The FSCA has already published desirable regulatory outcomes in principles and outcome-focused rules in the COFI Bill and they will continue to do so in the conduct standards, which will be published after the COFI Bill is promulgated by Parliament. Since so many best-practice business and legal principles are well-established in our industry, FSPs can proactively start to design their own business and compliance model under COFI. 

1 M Hopper and J Stainsby “Principled-based regulation-better regulation” (2006) 21 Journalof International Banking Law and Regulation 387 at 388
2 Making a success of Principles-based regulation by Julia Black, Martyn Hopper, Christa Band and Herbert Smith LLP, May 2007

14 June, 2023.

This series of articles is inspired by legendary author, the late Stephen R Covey, whose bestselling book, The seven habits of highly effective people, impacted millions of people around the world. FSPs will do very well to consider the habits highlighted in these articles. 

The first habit

As a quick reminder again, in the first article on the essential habits of highly successful FSPs under COFI, I highlighted the importance of defining reality and to be proactive. The reality is that the Conduct of Financial Institutions Act (COFI) is upon us, and it will impact your business. Best be proactive and start preparing for the next wave of regulatory reform.

The second habit – Seek first to understand, then to be understood 

In the previous articles (Parts 1, 2 and 3) I highlighted that it will be necessary to reassess and stress-test your business and your client engagement process before conducting business under the new Act. I also highlighted the importance of seeking first to truly understand the fundamentals of COFI before expressing an uninformed opinion and potentially leading your team in the wrong direction. In the first two articles I mentioned the significance of understanding the purpose or objective of the Act and that COFI does not stand on its own. It must be read with the Financial Sector Regulation Act as the FSR Act created the regulatory foundation for COFI to exist. The third article highlighted that FSPs should be aware that the principles of Treating Customers Fairly (TCF) will be officially incorporated into the COFI Act. These articles are available on in the Member Resources for those members who missed it. 

In this article the significance of culture takes centre stage.

Culture and Governance

The principles of ethical culture and corporate governance are the two cornerstones on which COFI is founded. In terms of section 14(1) of the Conduct of Financial Institutions Bill, a financial institution must identify and promote a culture within the financial institution that supports ethical behaviour and aims to ensure that the matters referred to in Part 1 of COFI, such as promoting confidence and trust in the financial sector, are central to the values and practices of the financial institution.

According to sociologists, culture consists of the values, beliefs, communication, and practices that people have in common. Essentially, culture is about the way you and your people treat other people, how you act in critical situations, how you manage pressure in the business, and how you respond to the myriad of challenges you face in this highly competitive and onerous environment. Imagine a culture in your FSP where all key individuals, representatives, and admin personnel-

(i) act in good faith and in the interests of your financial customers and treat them fairly.

(ii) conduct your business transparently, with integrity, honestly, fairly, and with due skill, care, and diligence.

(iii) ensure that financial products and financial services, and information relating to financial products and financial services, are provided, promoted, and marketed to financial customers in a way that is clear, unambiguous, and not misleading or fraudulent.

(iv) deal with conflicts of interest effectively and fairly and in accordance with any prescribed requirements relating to the avoidance or mitigation of conflicts of interests.

I am convinced that if all financial services providers conduct business in this manner, it will instil trust and customers will be very confident to deal with such businesses. As a customer, conducting business with me honestly, with integrity, fairly, transparently, with skill, care, and diligence, and acting in my best interest is what I would expect from any FSP. If your focus is establishing trusted relationships between your FSP and your clients, treating your clients in this way is the culture that you would want to cement in your FSP, and not because these examples of conduct are required in terms of section 12 of the COFI Bill. As far as market conduct legislation is concerned, advisors and intermediaries usually have one of two distinct vantage points, namely:

(a) Rules and regulations; or

(b) Trust

If you approach market conduct legislation from a rules and regulations point of view, COFI will overwhelm and irritate you. Then it is easy to consider it as a barrier to do business. However, if you approach COFI with the perspective that at its core, the objective is to promote confidence and trust, and that most of its provisions are enablers that help to create trusted relationships between advisors and clients, you will consider COFI as a sound business guide that will enable you to conduct good business.

My advice: Choose your vantage point wisely.

This series of articles is inspired by legendary author, the late Stephen R Covey, whose bestselling book, The seven habits of highly effective people, impacted millions of people around the world. FSPs will do very well to consider the habits highlighted in these articles. 

The first habit

As a quick reminder again, in the first article on the essential habits of highly successful FSPs under COFI, I highlighted the importance of defining reality and to be proactive. The reality is that the Conduct of Financial Institutions Act (COFI) is upon us, and it will impact your business. Best be proactive and start preparing for the next wave of regulatory reform.

The second habit – Seek first to understand, then to be understood 

In the previous articles (Parts 1 and 2) I highlighted that it will be necessary to reassess, and stress-test your business and your client engagement process before conducting business under the new Act. I also highlighted the importance of seeking first to truly understand the fundamentals of COFI before expressing an uninformed opinion and potentially leading your team in the wrong direction. 

In the previous two articles I mentioned the significance of understanding the purpose or objective of the Act and that COFI does not stand on its own. It must be read with the Financial Sector Regulation Act as the FSR Act created the regulatory foundation for COFI to exist. These articles are available in the Member Resources for those who missed it.

The third aspect that FSPs should be aware of is that the principles of Treating Customers Fairly (TCF) will be incorporated into the COFI Act.

As recorded on the FSCA website, Treating Customers Fairly (TCF) is an outcomes based regulatory and supervisory approach designed to ensure that regulated financial institutions deliver specific, clearly set out fairness outcomes for financial customers. Regulated entities are expected to demonstrate that they deliver the following six TCF Outcomes to their customers throughout the product life cycle, from product design and promotion, through advice and servicing, to complaints and claims handling:

– Customers can be confident they are dealing with firms where TCF is central to the corporate culture;

– Products & services marketed and sold in the retail market are designed to meet the needs of identified customer groups and are targeted accordingly;

– Customers are provided with clear information and kept appropriately informed before, during and after point of sale;

– Where advice is given, it is suitable and takes account of customer circumstance;

– Products perform as firms have led customers to expect, and service is of an acceptable standard and as they have been led to expect; and

– Customers do not face unreasonable post-sale barriers imposed by firms to change products, switch providers, submit a claim or make a complaint.

This series of articles is inspired by legendary author, the late Stephen R Covey, whose bestselling book, The seven habits of highly effective people, impacted millions of people around the world. FSPs  will do very well to consider the habits highlighted in these articles.

As a quick reminder, Covey asserted that the following personal habits would lay the foundation of success:

1. Be Proactive

2. Begin with the End in Mind

3. Put First Things First

4. Think Win-Win

5. Seek First to Understand, Then to Be Understood

6. Synergize

7. Sharpen the Saw

The first habit

In the first article on the essential habits of highly successful FSPs under COFI, I highlighted the importance of defining reality and to be proactive. The reality is that COFI is upon us, and it will impact your business. Best be proactive and start preparing for the next wave of regulatory reform.

The second habit

Seek first to understand, then to be understood 

Our industry is full of opinionated individuals, including me. Looking back, I am often ashamed of how many times I have been quick to express an opinion on a subject before fully understanding the context and its fundamentals. For any one of us to assume that COFI will simply be a ‘cut and paste’ of FAIS will be a mistake. A word of caution – Assumptions about COFI based on uninformed opinions may be the downfall of many FSPs. One thing is for sure – it is not simply going to be business as usual under COFI. Yes, there are many principles in FAIS that will be incorporated in COFI, but it will definitely be necessary to reassess, and stress-test your business and your client engagement process before conducting business under the new Act. My advice: Seek first to truly understand the fundamentals of COFI before expressing an uninformed opinion and potentially leading your team in the wrong direction. One of the first aspects of any piece of legislation that one needs to understand is the purpose or objective of the Act. It applies to all financial institutions, which creates a level playing field.

The objective of the Conduct of Financial Institutions Act

To provide for a regulatory framework for the conduct of financial institutions that will—

– protect financial customers, including by promoting the fair treatment and protection of financial customers by financial institutions;

– support fair, transparent and efficient financial markets;

– promote trust and confidence in the financial sector;

– support innovation and the development of and investment in sustainable innovative technologies, processes and practices;

– support sustainable competition in the provision of financial products and financial services;

– promote financial inclusion;

– promote transformation of the financial sector; and

– assist the South African Reserve Bank in maintaining financial stability; and to provide for matters connected therewith.

This series of articles is inspired by legendary author, the late Stephen R Covey, whose bestselling book, The seven habits of highly effective people, impacted millions of people around the world. FSPs will do very well to consider the habits highlighted in these articles.

The first habit

In the first article on the essential habits of highly successful FSPs under COFI, I highlighted the importance of defining reality and to be proactive. The reality is that the Conduct of Financial Institutions Act (COFI) is upon us, and it will impact your business. Best be proactive and start preparing for the next wave of regulatory reform.

The second habit – Seek first to understand, then to be understood 

In the previous article (Part 1) I highlighted that it will not simply be business as usual under COFI. It will be necessary to reassess, and stress-test your business and your client engagement process before conducting business under the new Act. My advice: Seek first to truly understand the fundamentals of COFI before expressing an uninformed opinion and potentially leading your team in the wrong direction. 

In the previous article I mentioned that one of the first aspects of any piece of legislation that one needs to understand is the purpose or objective of the Act. The second aspect of COFI that is of importance is to understand COFI in the broader context of the legislation.

COFI and the Financial Sector Regulation Act

COFI does not stand on its own. It must be read with the Financial Sector Regulation Act as the FSR Act created the regulatory foundation for COFI to exist. For purposes of this article, I will only highlight the key objectives that are specifically applicable to FSPs:

– To establish a system of financial regulation by establishing the Prudential Authority and the Financial Sector Conduct Authority, and conferring powers on these entities; 

– To preserve and enhance financial stability in the Republic by conferring powers on the Reserve Bank; 

– To regulate and supervise financial product providers and financial services providers; 

– To improve market conduct in order to protect financial customers; 

– To provide for coordination, co-operation, collaboration and consultation among the Reserve Bank, the Prudential Authority, the Financial Sector Conduct Authority, the National Credit Regulator, the Financial Intelligence Centre and other organs of state in relation to financial stability and the functions of these entities; 

– To provide for making regulatory instruments, including prudential standards, conduct standards and joint standards; 

– To make provision for the licensing of financial institutions; 

– To make comprehensive provision for powers to gather information and to conduct supervisory on-site inspections and investigations; 

– To provide for the protection and promotion of rights in the financial sector as set out in the Constitution; 

– To provide for coverage of financial product and financial service providers by appropriate ombud schemes; 

– To establish the Financial Services Tribunal as an independent tribunal and to confer on it powers to reconsider decisions by financial sector regulators, the Ombud Council and certain market infrastructures.

10 May, 2023.

The first responsibility of a leader is to define reality.

Max De Pree

American businessman

To say that financial services providers are under pressure would be a gross understatement. With the waves of regulatory reform that the industry has experienced over the last two decades, political instability, state capture, fraud, corruption, economic challenges, looting, Covid and loadshedding, financial advisers and intermediaries are facing yet another wave of legislation. In my opinion, the greatest challenge FSPs are going to face during the next few years is a lack of capacity to deal with all the regulatory changes that are coming in the midst of the perfect storm that is going on around us as South Africans.

With this series of newsletters, I am going to stand on the shoulders of a giant, the late Stephen R. Covey, author of many books, but most famously known for The Seven Habits of Highly Successful People. 

Be proactive!

Covey’s first habit is the habit of being proactive. Reactive people are driven by feelings, by circumstances, by conditions, by their environment, and they tend to wait until it is almost too late. I am afraid that, with all the variables that FSPs have to deal with, the lack of capacity to deal with everything at the same time may just be one of the main causes of business failure in the future. If we think back to 2004, it is safe to say that financial services providers were ill prepared. We were not ready for the implementation of the Financial Advisory and Intermediary Services Act. We have been given notice since 2002 when the Act was promulgated, but we were not ready. As an industry, there were only a handful of FSPs that were prepared for the changes. For the rest, we were reactive, and not ready. The myriad FAIS Ombud determinations against financial services providers in the beginning of the implementation of the FAIS Act offers some proof of this fact. Respectfully, even after almost 20 years of FAIS, many FSPs still struggle with the correct and consistent application of a Record of Advice.

In a few months the Conduct of Financial Institutions Bill will be promulgated, and the industry is given fair warning that this Bill is going to change the Regulatory landscape yet again. Is the industry prepared? I do not think so. However, in mitigation, currently there are so many things that are going on at the same time, that business owners and key individuals do not have the capacity to prepare properly for what is coming.

However, with COFI there is a wave of market conduct legislation building up that can potentially be devastating to many FSPs if business leaders do not take proactive steps to start planning for it. As the adage goes, failing to plan is planning to fail. Why plan proactively? It is simple. It is better to plan without being pressured to implement something quickly without proper consideration. We are already under pressure, and it will be better for us to brainstorm a COFI strategy properly before it comes into effect than to have gaps in our plans when it becomes law. That way we create capacity to deal with the changes. 

How to plan proactively?

Start to participate in our COFI conversations. It is not what happens to us, but our response to what happens to us that often hurts us. Become part of the Trusted Advisor community. Together we will be much stronger.

If a house is built on a strong foundation, neither strong winds nor pouring rain will be able to pull it down.

The same applies to your business. You cannot build a great business on a weak foundation. You must have a rock-solid foundation if you want any chance of success in an extremely competitive and onerous financial services environment.

Alan Greenspan, the former chairperson of the US Federal Reserve, made this very profound statement about the significance of a foundation:

To succeed, you will soon learn, as I did, the importance of a solid foundation in the basics of education.

 

It is worth noting that the financial services industry is founded on quality education. With a strong foundation of quality education, we can build, grow, and sustain our practices, and on that foundation, we will be able to innovate to stay at the cutting edge of our profession. Without it, whatever we try to build will come crumbling down at some point. It is for this reason that we must ensure that the education courses in our industry are not simply there to tick a compliance box.

Sadly, with some providers education has been reduced to finding the quickest way to tick a minimum standard compliance box. Many advisors are lining up for all the free CPD modules and courses, mainly because they are made available at no cost, and not necessarily because they add fundamental value to the quality of the business. Whilst we appreciate the taxing cost of compliance, we believe that quality education will always come at some cost.

Nelson Mandela said, “Education is the great engine of personal development. It is through education that the daughter of a peasant can become a doctor, that the son of a mine worker can become the head of the mine, and that a child of farm workers can become the president of a great nation. It is what we make out of what we have, not what we are given, that separates one person from another.”

The difference between the two equally gifted advisors is the quality of education and ongoing professional development. We believe that, when it comes to the investment in quality education, providers should consider a value-for-money approach rather than simply selecting the free modules on offer.

Remember:

Education is the most powerful weapon which you can use to change the world. – Nelson Mandela