Approach with care when considering twin peaks

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In his 2011 Budget speech, Finance Minister Pravin Gordhan announced that South Africa would reform its financial regulatory structure by, among other things, adopting a twin peaks model.

In simple terms, a twin peaks model can be described as a method that places responsibility for prudential regulation of financial institutions with one regulator, and supervision of business conduct and consumer protection with another.

Gordhan explained that this decision was taken “in line with global developments to enhance the regulatory framework and improve financial services”. Since then, the National Treasury has released a few discussion papers articulating the proposed reforms.

Perhaps the most significant of these are “Implementing a Twin Peaks Model of Financial Regulation in South Africa” (2013) and “A Safer Financial Sector to Serve South Africa Better” (2011). In these documents, the Treasury makes the case for the plan to adopt a twin peaks model.

It explains that the Treasury considered three options for reform and concluded that the adoption of twin peaks would be less disruptive. It argues that “after the financial crisis broke out in 2007, there was a global shift away from the single regulator model towards a twin peak.

“In line with international trends, South Africa will now be adopting the twin peak model for financial regulation instead of a single regulator model.”

This decision is contrary to the recommendation of the 1993 Melamet Commission, which recommended a single regulator model for South Africa.

A legislative proposal by the Treasury was released for public comment in December last year in the form of the Financial Sector Regulation Bill. The bill proposes the establishment of two regulators. One will be known as the Prudential Authority, housed in the Reserve Bank and focusing on safety and soundness of financial institutions. The other is the Market Conduct Authority, formerly the Financial Services Board, which will focus on business conduct and consumer protection.

One possible concern is that the current debate is framed in such a way that South Africa must choose among three things: doing nothing, a single regulator or the twin peaks model.

As Professor Eric Pan said of Canada, South Africa “must not let itself fall into this trap to believe that it has to make a choice between single regulator or twin peaks models”.

Rather, as Pan has suggested, the most important mission for every country considering reform of its financial regulatory structure must be to ensure there is sufficient regulatory co-ordination, information sharing and allocation of resources.

Like Canada, whatever model South Africa chooses to adopt must ensure that there is a legal framework that will promote co-ordination of regulatory policy, co-operation on enforcement matters and the sharing of information between two regulators or within a regulator, assuming a single regulator is the way to go.

My concern at the moment is that the bill does not sufficiently promote these considerations. While the bill would establish the Financial Stability Oversight Committee and the Council of Financial Regulators, these bodies would not have independent legal authority to act. They could only make recommendations.

While chapter 4 of the bill promotes co-operation and co-ordination – such as by requiring memorandums of understanding between the two regulators – I doubt this will sufficiently address one of the greatest potential weaknesses of twin peaks, which is the need for co-ordination between the two regulators.

Instead of the current proposals in the bill, I suggest a permanent co-ordinating body between the two regulators and independent legal authority for such a body to address the above considerations.

In its discussion documents, the Treasury’s main reasons for moving towards twin peaks are that “it would be less disruptive” and that it is the “global trend”. While it is true that many countries have reformed their regulatory structures since the 2007 financial crisis, it is an overstatement to say that there has been a global shift towards twin peaks.

Only two countries, the UK and Canada, adopted twin peaks under pressure from the aftermath of the crisis.

The UK reforms are the most notable. They began in 1997 when the Labour Party came to power. It reformed the regulatory system by adopting a single regulator under the Financial Service and Markets Act of 2000 even though the justifications for these reforms were based on twin peaks.

As Dr Michael Taylor has noted, these reforms were not well thought through, but were driven by the need to satisfy the parliamentary timetable and the mistrust of the Bank of England as a prudential regulator. After the crisis, the coalition government led by the Conservative Party quickly made a decision to move the UK towards twin peaks.

In the investigations that occurred after the crisis, some officials in the UK’s Financial Services Authority (FSA) admitted that the agency had neglected prudential supervision, which had led to the regulatory failures.

In his study of the UK regulatory system after the crisis, Taylor remarked that one of the reasons for the failures in the UK was lack of co-ordination in the FSA. Furthermore, business conduct regulation was favoured because it is considered more important and politically sensitive since its results are easier to measure than prudential supervision.

Hence, it was and always is easy to neglect prudential regulation whether one is operating under a single regulator or twin peaks model. Most commentators agree that the failures in the UK were not caused by the single regulator model but by the lack of co-ordination.

The two other countries that have adopted twin peaks are Australia and Netherlands. Australia was the first to do so, in 1998, following the recommendations of the Wallis Inquiry of 1996. Wallis was motivated by Taylor’s paper titled “Twin Peaks: A Regulatory Structure for the New Century” (1995). In that paper, the concept of twin peaks was conceived.

The Netherlands adopted twin peaks because of the unique regulatory circumstances in that country, which required it to reduce the number of financial regulators and the opportunity for regulatory arbitrage. The Netherlands was also influenced by the broader regulatory changes in the EU, something that is not entirely relevant to South Africa. Despite having adopted twin peaks, the Netherlands has had its own share of financial sector failures, which twin peaks did not prevent.

In my view the adoption of twin peaks by two countries after the financial crisis cannot reasonably be said to represent a global shift.

Other countries that have reformed their regulatory structures have endorsed certain elements of twin peaks, but not entirely, and they have done so after many years of research and in order to address specific problems in their countries.

In the US, Professor Reene Jones observed that while the administration of President Barack Obama embraced some aspects of twin peaks, through the enactment of the Dodd-Frank Act in 2012, it did not embrace all aspects of twin peaks because it felt they were not suitable for its financial sector. Some have even described the reforms in the Dodd-Frank Act as the “three peaks” model.

My concern is that South Africa may be on the verge of adopting twin peaks without fully studying the alternatives at its disposal and justifying the suitability of implementing twin peaks given the unique circumstances of our financial sector.

However, what is comforting is that like the Wallis Inquiry in Australia, Melamet’s recommendation was made under no particular pressure.

I believe that if South Africa has to move towards twin peaks, it should consider a modified version that responds to the peculiar local circumstances.

Such a modified version should be informed by comprehensive local research of the financial sector. I have some reservations about the wisdom of entrusting consumer protection to the Market Conduct Authority when its prospective predecessor has no experience in this area.

Moreover, the fact the retirement funds and insurance sectors were exempted from the consumer legislation (the legalities of which are yet to be determined by our courts) suggests that consumer protection is not embedded in these sectors.

The proposal to adopt twin peaks is an important step in the transformation of the financial sector and of society in general. As a result, such proposal has to be carefully studied and handled with care.

Associate Professor Mtende Mhango teaches and supervises post-graduate students in pension fund law at the University of the Witwatersrand School of Law, where he is also the deputy dean.


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