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FINANCIAL ADVISORY AND INTERMEDIARY SERVICES ACT, 2002 (ACT NO. 37 OF 2002) DATE OF PUBLICATION: 4 DECEMBER 2014

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FINANCIAL ADVISORY AND INTERMEDIARY SERVICES ACT, 2002 (ACT NO. 37 OF 2002)

DATE OF PUBLICATION: 4 DECEMBER 2014

RESPONSE OF THE REGISTRAR OF FINANCIAL SERVICES PROVIDERS TO COMMENTS RECEIVED ON PROPOSED AMENDMENT TO THE GENERAL CODE OF CONDUCT FOR AUTHORISED FSPS AND REPRESENTATIVES, 2003 1. PURPOSE

The purpose of this document is to respond to key issues raised in the comments received on the proposed amendment to the General Code of Conduct for Authorised FSPs and Representatives, 2003 (General Code), released by the Registrar of Financial Services Providers (Registrar) on 1 September 2014.

2. COMMENTATORS

Comments were received from the persons listed in Annexure A.

3. THE COMMENTS

A large number of comments were received on the proposed prohibition of sign-on bonuses. Commentators were mostly supportive of the Registrar‟s objective to curb incentive driven churn of financial products by prohibiting incentives that encourage providers to churn often resulting in advice to clients that does not take the best interest of the client into account. However, there were differing views as to whether the offering of sign-on bonuses encourages such practices. Concerns were also raised regarding perceived unintended consequences of such a prohibition.

The Regulator‟s response is structured to address the key issues and concerns raised with the proposed prohibition collectively rather than per comment received.

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4. GENERAL RESPONSE

The prohibition of sign-on bonuses should be viewed in the context of the Financial Services Board‟s (FSB) concerns regarding conflicted distribution models and practices that pose a risk to fair customer outcomes, to sustainable models for advice and to supervisory effectiveness - as discussed in detail in the Retail Distribution Review (RDR) document published by the FSB on 7 November 2014.

More particularly, sign-on bonuses exacerbate the risk of inappropriate bias toward tied distribution models, as well as the risk of incentive driven “churn” of financial products that may not be in customers‟ interests. This conflict of interest is exacerbated by sign-on bonuses, where intermediaries are explicitly or implicitly incentivised to meet the production expectations of their new financial services provider (FSP). Recommending product replacements to the new FSP‟s product range is typically the most common way of meeting such expectations. In the long-term insurance sector in particular, this is further exacerbated by the opportunity to earn new up front commission on policy replacements.

The payment of sign-on bonuses creates untenable conflicts that result in inappropriate behaviour. This is not in the best interest of the client and not in the interest of the financial services industry as it militates against level playing fields, and ultimately increases the cost of financial products offered to consumers.

The risks of conflict posed by ways in which providers are remunerated have been a concern of the FSB for a number of years. Various interventions have been put in place to mitigate these risks, however this concern remains. The prohibition of sign-on bsign-onuses is therefore a further step towards addressing this csign-oncern. It will not result in alleviating the concern fully and is an interim intervention that may be reconsidered or refined once the more comprehensive range of structural reforms to incentives, relationships and business models proposed in the RDR have been finalised and implemented.

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referred to as providers) it may result in unintended consequences. Therefore, during the interim period, the prohibition will only apply to Category I providers.

However, this does not mean that the other categories of providers are not under regulatory scrutiny or that they are not required to avoid conflicts of interest. The General Code of Conduct is clear in its scope. A provider must avoid all conflicts of interest; only when it is not possible must the conflict be mitigated. This is a peremptory provision. However, certain providers regard certain conflicts as being impossible to avoid despite it being within their means and ability to avoid it. In these circumstances mere disclosure of the existence of such conflicts does not constitute compliance with the requirement. Going forward, the Registrar intends to interrogate providers‟ compliance with this peremptory provision and where contraventions are detected to take enforcement action. In addition, the Registrar intends to review the Discretionary Code of Conduct which will include a review of the conflicts inherent in the business activities of a discretionary provider.

A number of the comments received focussed on specific aspects of remuneration models and queried whether these would, or were intended to, fall within the scope of the prohibition on sign-on bonuses Although general responses to some of these scenarios are provided below, the Registrar urges providers who are in any doubt as to whether any specific practice may fall foul of the prohibition, to consult with the Registrar for guidance as to whether such practice constitutes a sign-on bonus or other breach of the General Code relating to conflicts of interest, before making or accepting any such offer.

The Registrar recognises that the mischief which the proposed prohibition seeks to address is not caused by new entrants to the industry. Therefore, the Regulator has decided that this prohibition will not be imposed on new entrants to the industry.

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RESPONSE TO PARTICULAR CONCERNS RAISED

A. Does the Registrar have the power to regulate product suppliers under

the FAIS Act?

Some commentators suggested that the proposed amendment is ultra vires as it purports to regulate the conduct of product suppliers.

The proposed amendment does not apply to product suppliers and does not seek to place obligations on product suppliers. It applies to providers only. However, it is correct that the prohibition will apply to a product supplier where that product supplier is also a provider.

The FAIS Act is applicable “in addition” to any other law and specifically provides that authorisation granted to a product supplier under the FAIS Act is supplementary to, but separate from, the supplier‟s authorisation under any other law.

In other words, the FAIS Act encompasses a functional approach to achieving its objective of regulating financial services and protecting the interests of consumers; it is irrelevant in which capacity a person renders the services. The Registrar therefore disagrees with the statement that the proposed amendment is ultra vires.

B. Does the Registrar intend to regulate persons to whom non-regulated

activities are outsourced?

Some commentators indicated that the regulator, through the insertion of the definition of “outsourced” and the amendment to the definition of “third party”, intends to regulate activities and persons that fall outside the ambit of the FAIS Act.

The proposed amendment does not apply to “third parties” and does not seek to place obligations on persons who are not providers.

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“third party” in the prohibition clause is merely intended to clarify what could constitute „indirectly‟.

However, the Registrar agrees that the prohibition can effectively be implemented without specifically referring to a “third party” as the reference to “any person” is wide enough to include a person to whom a function has been outsourced.

The proposed amendment to the definition of “third party” and the consequential insertion of a new definition of “outsourced” has therefore been removed.

C. The prohibition unfairly impacts on freedom of trade

Some commentators expressed the view that the proposed prohibition will restrict the freedom of representatives to change employers e.g. a new employer will not be permitted to release a representative from a restraint of trade agreement or to compensate him/her for any forfeited income.

The Registrar disagrees that the prohibition will unfairly impact on a provider‟s freedom of trade. Although a person, under our Constitution, has the right to choose their trade, occupation or profession freely, the Constitution allows that the practicing of that trade, occupation or profession may be regulated by law. The prohibition regulates certain practices associated with the rendering of financial services only; it does not impact on the right to choose or unfairly denies or prohibits access to the industry.

The Registrar respects a provider‟s right to contract with employees or other contractors and does not intend to interfere with that right other than to achieve its regulatory objectives. It must be noted that a provider‟s right to contract with employees is currently already limited by legislation, e.g. a FSP can only appoint a representative who is fit and proper, the General Code prohibit certain forms of financial interests, insurers are only allowed to pay prescribed commissions on prescribed terms, and the like.

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The prohibition strengthens the overriding principle that conflicts must be avoided by restricting certain types of incentives that are offered to a person to become a provider.

D. The prohibition limits the acquisition of a business, books of business or

future income streams

Some commentators were concerned that the proposed prohibition will limit providers seeking to expand their businesses by the acquisition of books of business from existing providers.

The prohibition does not restrict providers from selling or buying a business or a book of business provided fair value was paid or offered for it. However, an offer to a person to become a provider that is connected directly or indirectly to an offer to acquire a business or a book of business at price exceeding fair value is unacceptable and is regarded as a prohibited sign-on bonus.

E. Will share incentive schemes be prohibited?

Sign-on bonuses must be distinguished from normal employee remuneration arrangements. A sign-on bonus is an incentive offered to induce a person to move to a new employer, which inducement is not consistent with the remuneration arrangements that apply equally to all other employees irrespective of those employees being providers or not.

In other words, the right to participate in a provider‟s employee share incentive scheme will most likely not be regarded as a sign-on bonus if all the employees of that provider are entitled, on an equal level, to participate in the scheme. The Registrar has however become aware of recent recruitment offers in the market where share incentives appear to be specifically designed to achieve the same result as a more explicit form of sign-on bonus, and intends to scrutinise such models carefully. Providers are also reminded of the existing provisions in paragraph

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interests to its representatives that give preference to quantity of business to the exclusion of quality of service.

F. The prohibition will impact on the expansion of a provider’s business or

operations

Commentators required clarity as to whether providers would be able to extend their “footprint” eg. by opening and furnishing an office at a specific venue and appointing a provider to manage the office.

The prohibition does not restrict a provider from expanding its operations through the establishment of offices that are managed by newly appointed representatives. Neither does it prohibit a provider providing its representatives with normal office amenities in order for them to perform there functions. However, these amenities must be equally available to all representatives of a provider fulfilling comparable functions. It further follows that ownership of the office, furnishings or other amenities must remain with the provider and must not otherwise be excessive in relation to what would be reasonably necessary for representatives to fulfil their functions, otherwise it will constitute a prohibited sign-on bonus.

The General Code of Conduct already prohibits a provider from offering a financial interest as referred to above to another provider that is not a representative of the first mentioned provider.

G. Will the practice of providing a learnership base salary together with an

advance which is recouped from future commission be prohibited?

Some commentators were concerned that programmes offered to new entrants or learners that allow for a basic salary together with an advance which is recouped from future commission would be prohibited.

As explained under the heading “General Response” above, the prohibition on sign-on bsign-onuses will not apply to new entrants to the industry. However, a provider is still

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Code of Conduct. This means that it must avoid conflicts and, only where it is not possible, mitigate such conflicts. Therefore, a provider will not comply with the general requirement if it is responsible for creating situations that may result in conflicts of interests.

The Registrar, as regards providers who are not new entrants, recognises that industry may have to restructure remuneration arrangements to provide for basic salaries. Therefore the prohibition does not restrict a provider from structuring its remuneration arrangements in such a manner that it provides for a basic salary. However, such remuneration arrangements must be equally available to all employees and not only a select few.

Whether or not a remuneration arrangement amounts to a sign-on bonus is a factual question that will be considered against the provider‟s normal remuneration arrangements, the extent and equivalence of participation by all employees and whether the arrangement is commensurate to the services being provided.

A provider will no longer be allowed to offer, as part of its recruitment, any arrangement (other than in the case of new entrants) in the form of a loan or advance, especially where the repayment or continuation of such loan or advance is linked to production criteria.

In assessing whether a particular arrangement constitutes a sign-on bonus, the Registrar will be guided by the overriding principle that an arrangement must not result in an inappropriate incentive being offered to a person to move from one provider to another.

H. Equivalence of reward should be reviewed

Some commentators requested the Registrar to review the concept of equivalence of reward to ensure level playing fields.

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ANNEXURE A LIST OF COMMENTATORS

Banking Association of South Africa The Unlimited

Efficient Group Ltd Innovation Group

FirstRand Group FAIS Compliance South African Venture Capital Association

Financial Planning Institute of Southern Africa Howard Silk

FNB Charmaine van Wyk

Marsh Africa Rita Loots

Renaissance Insurance Brokers Johann Meyer

Masthead Brian Vincent

Archenfield Greg Buckle

Oldmutual Dawn Julyan

PSG Konsult Tom Fecher

Standard Bank Group Risk Regulatory Advocacy Cynthia Baxter Credit Suisse Securities (Johannesburg) (Pty)

Ltd Lawrence Smit

ASISA Petricia Buurman

Momentum Ricky Williams

Investec Nick Dekker

South African Insurance Association Nikki Taylor

Renaissance Capital Pankie Kellerman

Rothchild Jose Proenca

Liberty Charles Moodley

ABSA Alwyn Smit

Consolidated Maeve Maroun

Discovery Warwick Wealth

PPS Coronation Fund Managers

AllanGray Analytics

Financial Intermediaries Association of Southern Africa

References

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