Like a large, heavy-laden cargo ship slowly gliding towards the harbour, the Conduct of Financial Institutions Bill (CoFI) is starting to influence practice management considerations. But the harbour is Cape Town in windy December, and who knows how long it will be before the ship finally docks? For those who may be wondering if they missed the memo with the date when CoFI will fully be in effect, there isn’t one. What we have is a period of time stipulated in the Financial Sector Conduct Authority (FSCA)’s updated three-year Regulation Plan as being 1 April 2023 to 31 March 2026, during which developments will develop, changes will change, and new regulations will gradually be phased in. These will affect the entire financial sector, so it would be prudent to use the time wisely.
How did we get here?
The aim of CoFI is to consolidate all the many bits of legislation governing different aspects of the financial services sector into one standard (the CoFI Act) that will be applicable to all.
CoFI arose out of a broader reform of financial sector regulation that began with the decision, back in 2011, to shift to a Twin Peaks model, where the Prudential Authority manages prudential risk and the FSCA manages market conduct risk, while the South African Reserve Bank overseas the stability of the financial sector in South Africa. This came into effect in 2018.
CoFI is designed to protect the customer in line with Treating Customers Fairly principles (TCF). In the Explanatory Policy Paper that accompanied the first draft of CoFI, national treasury stated, “The protection of customers in the financial sector, and meaningful financial inclusion in South Africa, are mutually reinforcing objectives. The market conduct policy approach should therefore be seen as a supporting pillar of South Africa’s financial inclusion policy – higher standards of customer protection can drive greater inclusion as customers feel more secure in their participation in the financial sector.”
Current state of play
CoFI is complex and comprises many moving parts. It is set to be tabled in parliament before the 2024 elections, but according to the FSCA’s three-year Regulation Plan, development of a “holistic, cross-sector, robust and customer-focused regulatory framework” has been progressing well. The framework comprises three phases that are being rolled out concurrently.
Phase 1, the overall design of the new framework, has been developed, although the plan is for it to evolve and be refined over time as the transition work progresses.
Phase 2, the development of the harmonisation frameworks, is under way, with the initial frameworks, for FSCA internal purposes, having been developed. Following targeted industry consultation, these are due to be published for public comment in the first half of 2024. Something to note is that these have been expanded to include sector specific requirements per theme where necessary. The paper explains: “As an example, a framework for ‘disclosure’ will be developed containing high level cross-sector disclosure requirements that apply across all financial institutions (e.g. as a Chapter), but the framework will also contain additional Chapters that contain industry specific requirements pertaining to disclosure, e.g. Chapters dealing with collective investment scheme disclosure, asset manager disclosure, financial advisor disclosure, and the like.”
With this in mind, the recommendation is for these frameworks to be referred to as “themed frameworks”.
Phase 3, transition work, has begun, with an assessment having taken place to determine any overlap between existing laws and pending regulatory instruments, and CoFI. This will inform what can be deleted and incorporated into the themed frameworks of phase 2, and how remaining requirements should be transitioned into the new framework under CoFI, if at all. Other ongoing policy projects are also being assessed to see how they can be incorporated into the transition work. This has been continuing throughout 2023 and the goal is to have initial formal proposals ready in the first half of 2024. However, the consultation and implementation could happen in a staggered manner over a period of years, based on priority.
All the deliverables for other cross-sector/cutting projects have been achieved.
Looking at Financial Advice and Intermediary Services specifically, the paper states: “All FAIS project deliverables contained in the Regulation Plan were achieved. These include: draft amendments to FAIS Ombud Rules that were published for comment; Amendment of the General Code of Conduct and Compliance Officer qualifications Notice under the FAIS Act; and finalisation of the Declaration of crypto assets as a financial product.”
Beyond tick boxes
In order to understand how CoFI will affect the industry, as well as individual practices, it’s worth understanding the spirit of CoFI.
Compliance has traditionally been viewed as a box-ticking exercise. This is not the case with CoFI. Under CoFI, there will be additional compliance. Notably, TCF principles will be legally binding. However, compliance will look a little different. Financial institutions will have outcomes they need to achieve, but how they achieve those outcomes is not prescribed. This flexibility can be seen as a frustrating grey area for those who prefer a checklist of requirements that shows them where they stand. But viewed through another lens, it leaves room for businesses to find what works for them. It also creates an environment where financial institutions have to embrace the spirit of CoFI entirely as opposed to ticking off the bare minimum requirements to pass a compliance test.
Anton Swanepoel, Practice Management and Compliance Coach at Trusted Advisors has offered much valuable guidance on the subject of how best to prepare for CoFI. Writing in an earlier issue of this publication, he noted that “Some FSPs are business driven in a compliant way, which is good for business, and some are compliance driven, which usually leads to poor adviser and poor client experiences.” If you missed the article, it’s worth a read: click here.
Speaking at the 2023 Glacier Invest Summit, Swanepoel pointed out that knowing your client is what lies at the heart of CoFI. That’s because, when it comes to advisers, one of the key objectives of CoFI is to ensure that clients are receiving suitable advice – a key outcome of TCF.
He explained that an important part of suitable advice is risk profiling – not to be confused with risk tolerance, which is only part of it. Risk profiling comprises risk tolerance, risk capacity and required risk. A good understanding of these will go a long way towards truly understanding the needs of the clients and building a plan that addresses those needs.\
Of course, it’s not only the spirit of CoFI that will impact Financial Institutions; there are some very real and challenging practical considerations, too. Writing in SA Financial Regulation Journal, Hayley Brown, Head of Business Solutions at Glacier Invest, laid out three ways CoFI will impact advisers.
Operational practices: To meet the compliance requirements of CoFI, practices will need to have comprehensive client relationship management (CRM) systems in place.
Operational working capital: Under CoFI, an adviser practice will need to be sufficiently capitalised to cover “the risks to which it is exposed or is likely to be exposed to in the future.”
Transformation plan: All adviser practices with annual turnover of more than R10 million will need a transformation plan that takes them to a level 4 B-BBEE contributor or face serious fines. This will also affect providers, which could be liable for paying commission to practices that have not met the transformation requirements.
Writing in Blue Chip Digital, Guy Holwill, Chief Executive of Fairbairn Consult, noted the impact of these concerns on adviser practices. He observed that the first two – and especially the requirements around working capital – would most severely impact smaller businesses. He posed the question, “Given the experience during COVID, can you demonstrate that you have enough capital to ride out a global pandemic where markets may crash 30% or more and many of your clients lose their businesses or become unemployed?”
Facing these looming regulatory changes, it’s conceivable that smaller businesses may have to consider merging, pooling their resources so that they’re able to meet the requirements. However, that could put them in the position where they now have to meet the third requirement – which will also impact their relationships with providers.
So, where to from here?
As CoFI is set to disrupt the entire financial sector, the most important thing is to get up to speed on it now and stay up to date with CoFI developments. Holwill noted that in the past there have been advisers who only engaged with new legislation once it had already passed. Similarly, Swanepoel has written that surveys revealed more than 90% of leading firms in South Africa had not read the Bill.
With the amount of disruption that CoFI will bring, this is not a luxury that advisers can afford. It’s important to understand how CoFI will impact your individual business and decide in advance what will be the best course of action.
Holwill notes that for some, the decision may be to leave the profession, while others may choose to merge with other practices or join a larger practice with more resources.
For those who choose to continue, there may be big changes required. Swanepoel and Holwill have both emphasised the importance of being business-driven as opposed to legislation driven. For Swanepoel, a big part of that is getting the fundamentals of practice management right, as well as looking at the culture, values and principles in your business. As CoFI is designed to benefit the customer, practices that already put the customer’s needs first and have an honest relationship with customers built on trust will be primed to succeed.
When it comes to the capital aspect of CoFI, businesses may need to relook how they manage commissions. For some practices, this may mean keeping upfront commissions aside for a period of time. Others may need to switch to an “as and when” model to limit their liability.
And when it comes to transformation, those businesses that will be impacted need to start considering how they can adapt to meet this requirement in an authentic way that benefits the business, the client, and the profession. A more diverse profession makes financial advice more accessible to a bigger portion of the South African population.
Finally, being up to speed with the latest CoFI developments is essential to be able to participate in the process, and take advantage of opportunities to comment and voice concerns. The legislation will go through a number of reviews, which means a number of opportunities to influence it. In the closing paragraphs of the Regulation Plan, it states that: “the FSCA’s Regulation Plan is a three-year plan that will be reviewed annually to ensure the Plan is up to date and takes account of changing circumstances, emerging developments and risks, etc.
“The FSCA reiterates that stakeholder engagement and consultation is critical to ensure the framework is robust, promotes the fair treatment of financial customers and the efficiency and integrity of financial markets, is aligned to international standards, yet fit for purpose considering the domestic context. Stakeholders are therefore implored to participate in this process of legislative change to ensure optimal results for the financial sector and South Africa.”
The FIA has been engaging with the CoFI task team and has already contributed to a number of revisions being made, as outlined in Head of Legal and Regulatory Affairs Sam Williams’s article in this issue (see Stand United).
CoFI will disrupt business as we know it and ignoring it will only make the impact more pronounced. Now is the time to prepare.