The draft Conduct of Financial Institutions Bill was recently published. Once enacted, the CoFI Bill may become one of the first pieces of legislation that explicitly seeks to develop fintech regulation in South Africa.
Comments on the CoFI Bill close on 1 April 2019, and set out below are the key issues for industry stakeholders to note.
The CoFI Bill represents the culmination of industry reviews, discussions and proposed frameworks emanating from the need for an extensive reform of the market conduct regulatory framework applicable to the South African financial services sector.
The CoFI Bill is rooted in the financial service sector’s shift toward the Twin Peaks regulatory model, initiated by the commencement of the Financial Sector Regulation Act (FSR Act).
The adoption of the Twin Peaks framework has established two distinct pillars of regulation, the Prudential Authority and the Financial Sector Conduct Authority, both of which have focused mandates to manage prudential and market conduct risks, respectively. Since the enactment of the FSR Act, a number of strides have been made on the prudential regulatory side of the Twin Peaks isle, and with the promulgation of the CoFI Bill, the fundamental market conduct tread has commenced.
Beyond fair treatment
While primarily predicated on objectives aligned with the fair treatment of customers ; the CoFI Bill is cognisant of the need for market conduct regulation to go beyond the mere fair treatment of customers.
Accordingly, the legislative objectives underpinning the CoFI Bill are similarly aimed to promoting financial inclusion, transformation and competition, among others. In particular, the CoFI Bill seeks ‘to promote innovation and the development of and investment in innovative technologies, processes and practices’, which may serve as a core objective to which the development of fintech regulation may be anchored.
Compliance and enforcement
In terms of the risk and activity-based regulatory framework, proposed by the CoFI Bill, this fundamental objective not only impacts that overall regulatory approach of the Bill, but also the manner in which regulatory compliance will be assessed and the way in the Financial Sector Conduct Authority will implement and enforce the provisions of the Bill once it comes into force.
Innovative technology objective
As the objectives of the CoFI Bill may serve as the proposed first step in developing a South African fintech regulatory environment, this fundamental objective to promote the development and investment in innovative technologies raises an important question in the fintech regulatory debate – what does a South African fintech regulatory objective look like within a legislative context?
The CoFI Bill proposes that the development of fintech regulation in South Africa will be premised, primarily, on the apparent need to ‘promote innovative technologies’ within the sector. This need arises out of the concern that the labyrinth of financial services regulation may inadvertently restrict or prevent the development, investment or deployment of technology in the industry. However, in an activity-based regulatory regime, as proposed by the Bill, connecting the fintech regulatory objective to the promotion of ‘innovative technologies’, in and of itself, may create superfluous fintech regulation.
Actual activity based
The mere utilisation of technology (innovative or otherwise) in providing traditional financial products and services in a manner that still ascribes to the current regulatory definition and industry understanding of such products and services does not necessarily warrant a regulatory eye or room for compliance flexibility.
In the proposed provisions of the CoFI Bill, it will be the actual activity related to providing financial products and services, as defined and recognised in the CoFI Bill, that be will subjected to the reformed market conduct regulatory regime – irrespective of the kind of technology utilised in conducting the regulated activity.
The financial services sector, like any other industry, is not immutable to the effects of technological innovation.
A number of distribution business models within the industry are currently digitised and in 2017, the fit and proper requirements promulgated under the Financial Advisory and Intermediary Services Act introduced the concept of ‘automated advice’.
The innovative capability of technology does not, generally, introduce a level of risk into the financial services industry that is significant enough to require the development of a regulatory framework that has a particular focus on the impact of technology. However, the same may not, necessarily, be said of the disruptive capability of technology, specifically when employed in this somewhat crystalized industry.
New technology, new product, new definition
Disruptive technology is not, generally, developed with the primary intention of innovating financial products and services in a manner that still aligns with the current incumbent industry model.
Instead, disruptive technology has the ability to reform the fundamental commercial and legal structure of particular financial products and services, in its entirety. Technologies, such a distributed ledgers, smart contracts and digital identities may not be easily confined to the current definition and understanding of a ‘financial products’ or an activity in rendering a ‘financial service’.
In an activity-based regulatory regime, as proposed under the CoFI Bill, a legislative objective that promotes the development of innovative technology, as opposed to disruptive technology, runs the risk of affording regulatory flexibility to technological developments that would not necessarily have been subject to any significant regulatory constraints – while inadvertently hindering the development of disruptive technology or ultimately excluding an emerging financial services micro-sector that has the potential to introduce significant risk to the industry as a whole.
While the CoFI Bill is its initial draft stages, and thus, may change prior to its promulgation, it nevertheless represents a cardinal direction for the development of fintech regulation in South Africa.
However, in determining the legislative objective that will form the foundation upon which a fintech regulatory environment will be built, it is important for the proposed legislation to acknowledge that not all technology is created equal.
As affirmed in the 2018 Fintech Programme media statement as well as the published Regulatory Strategy of the Financial Sector Conduct Authority, the type of fintech that should be the subject of regulation are ‘technologies applied to financial services with the potential to disrupt current business models, applications, processes or products…’.
As such, it is critical for any proposed fintech regulatory objective to be focused on the extent to which the relevant technology has a disruptive effect on the current structure of the industry, rather than the ability of technology to further entrench traditional constructs of financial products and services through innovative means.