Don’t play Cat (2) and mouse

Gerry Grispos, compliance officer, Compli-Serve SA.

The sheer quantity of compliance requirements for Category 2 FSPs can make it tempting for firms to play cat and mouse with the Regulator. But this is a dangerous game as the Financial Services Board makes regular announced site inspections to assess the state of compliance within these FSPs.

A Cat 2 license allows an FSP to manage its clients’ funds directly, without seeking their approval every time it makes a new investment decision. The stakes are therefore higher than in the Cat 1 space, which is no doubt why there are far more advisory brokers than discretionary brokers.

When consulting on compliance in the Cat 2 space, the first thing we look for is whether or not a company has all the relevant category licenses in place i.e. a license for each investment instrument the company trades in is required. You would surprised how often we find that a firm with a license for trading equities, for example, has moved into other asset classes without having the necessary approved license categories.

In addition to licenses, there is a virtual plethora of compliance paperwork for Cat 2s to understand, complete and submit on time. The bi-annual reports the Financial Services Board require can be a massive task, with questions that go on for 30 pages on more, and including everything from business structures, shareholding and directorship to the flow of paper and money through the organisation.

At the core of the compliance puzzle is the investment mandate agreed between the Cat 2 and its clients. It is perhaps the most important document signed as it is a written instruction by the client to the FSP on how to manage his/her money. In comparing client portfolios to the mandates we often find discrepancies between these which require immediate attention and rectification.

In addition to adherence to the General Code of Conduct Cat 2s need to adhere to the Discretionary Code of Conduct as well. The latter deals mainly with mandates between FSP and clients and the need to report back quarterly to clients.

All FSPs must adhere to strict financial soundness requirements with Cat 2s needing to keep, at all times, at least 8 weeks of annual expenditure in cash reserves. This requirement is increased further for Cat 2(a) hedge funds where 13 weeks of annual expenditure is required. This does place a strain on the cash flows of such FSPs.

Cat 2s need to place the interests of their clients above their own and in this respect where key management personnel trade for their own personal accounts such trading needs to be declared to the FSP to ensure no conflicts of interest.

Compliance in the Cat 2 space does not only revolve around compliance with FAIS and FICA but with a host of other legislation as well. These include, inter alia:

• The Companies Act
• The King III Report
• The Protection of Personal Information Act (POPI)
• Treating Customers Fairly (TCF)
• RDR (Retail Distribution Review)

All these requirements make compliance time consuming and costly, especially for smaller companies. There is no easy solution except to embrace compliance and ensure that the clients’ best interests are catered for.