Forget Afghanistan... The “conflict” regulators want to stamp out is playing out in your own back yard!
One of the best ways to keep on top of financial services regulation is to attend industry seminars and events. This September FAnews teamed up with Liberty to host a number of informative sessions on the Conflict of Interest (COI) amendments to the FAIS Code. We invited three respected industry stakeholders – a product provider, compliance expert, and FSB representative – to share their experiences as they prepare their respective businesses for the change.
Leanne Dewey
Executive: Legal & Regulatory, Liberty
“The prohibition on FSP incentives that aren’t specifically recognised as ‘permissible’ kicks in on 18 October 2010.”
Liberty prepared for COI in four stages, to coincide with the legislation’s implementation milestones. The first implementation date was on 18 July 2010, with the next milestone pencilled in for 18 October this year.
Any company not complying with the first phase - client disclosures - is already contravening the law, warned Dewey. In preparing for this date, Liberty focused on the interaction between their representatives, policyholders and other clients. The biggest challenge for a company with a large “tied” agency force is knocking heads against the ‘one-size-fits-all’ and tailor-made disclosures the regulators frown upon. Dewey said they reached a compromise by creating a standard disclosure template and including a “free format” section.
“The prohibition on FSP incentives that aren’t specifically recognised as ‘permissible’ kicks in on 18 October 2010,” said Dewey, commenting on the second phase of COI. Liberty undertook a massive group-wide exercise to make sure they considered every incentive imaginable. “We created a template and listed every component of remuneration that fitted the definition of financial interest, including cash, commission, discounts, benefit in advantage etc. We also listed every imaginable issue around ownership interests and third party relationships. This template was then distributed to each business unit with the request they complete a separate document for each agency, broker or franchisee they dealt with,” explained Dewey.
Business units were then instructed to list every element of their value proposition. “We wanted to get a complete picture of remuneration before conducting an analysis to test each item in terms of S3 (1) (a),” noted Dewey. Large insurers like Liberty Life have to consider their dual role as product provider and FSP. It becomes essential for the insurance division to consider the benefits received from other business units, for example. “The Liberty distribution force forms part of the life operations, but is a FSP with regards other group products they deal in,” she said.
Attention now shifts to the third phase, the implementation of Section 3(a) on representative remuneration, which kicks off on 18 April 2011. Liberty used the template from Phase 2 to determine the basket of “cash and kind” benefits received by representatives. The financial interests declared by each business unit were carefully scrutinised for permissibility in terms of the relevant section of the COI code, S3A (1) (b).
“So we asked questions such as whether a particular benefit gave preference to quantity to the exclusion of quality – and whether it gave preference to a specific product. There are always teething troubles with new legislation. The concept of quantity and quality would still have to be explored – as well as whether ‘preference’ would arise if the products sold addressed non-competing needs,” Dewey said.
The last “to do” on the list is the Conflicts Management Policy also due on April 2011. Listed companies like Liberty had to prepare well in advance for this date. For this reason, Liberty tackled the management policy in parallel with the second phase, with due consideration for the board’s timetable.
Hjalmar Bekker
Director, Moonstone
“We should have called this regulation the Policy of Ethics, because the only way to manage conflicts is through ethical behaviour.”
Hjalmar Bekker, Director at compliance company Moonstone, put a slightly different spin on COI. He kicked off his presentation with the simplest definition of COI we’ve seen thus far. “The legislation seeks to outlaw anything that will influence your objectivity and/or ability to do the right thing!” he said.
Each and every financial services provider must avoid conflicts – except where avoidance is not possible – in which case steps must be taken to mitigate conflict between provider and client. Bekker urged all present to re-read the board notice and make certain they understand it. He also warned against falling into the trap of implementing views rather than regulations.
COI compliance hinges on your acceptance of the conflicted nature of the industry. An adviser always has to balance his commission or fee with the client’s expectation of “fair” value. The first step toward becoming compliant is to acknowledge the vested conflict of interest between yourself and your client. The basic “test” you can take is to answer the following: If my client knew this, would he/she still complete the transaction with me? According to Bekker, COI should actually be called The Policy of Ethics, because the only way to manage the conflicts addressed by the regulations is through ethical behaviour.
How does a financial services provider prepare for the various implementation dates? It boils down to disclosing every possible conflict that exists between yourself and your client. Step one is to understand what “conflict” is and step two is to identify any possible conflict in terms of the definition. You have to declare any commissions or incomes you earn on the product in question – disclose shareholdings you may have in the product provider etc. And remember, each and every transaction you complete has the potential for conflict.
The 18 October deadline is even easier to understand. Bekker summarises it as follows: “You may not offer any benefits as product provider – and may not receive any as the financial services provider.” It’s going to be difficult for the product providers, because they’ve been “winning hearts” by providing incentive for decades. Product providers that offer extra commission, take intermediaries out for lavish lunches, offer tickets to rugby games and pay for entertainment packages will have to change their ways! This inbuilt business culture will also be tackled by the Treating Customers Fairly (TCF) project currently underway. In plain English: product providers may not give and financial services providers and intermediaries may not receive!
Wendy Hattingh
Head FAIS Supervision, Financial Services Board
“Conflict of interest is a principle-based regulation that must be applied every day – it cannot be implemented by ticking boxes!”
With most of the legislative aspects tackled by the first two speakers, Wendy Hattingh addressed some of the practical issues in the application of COI and its subsequent enforcement. She attempted to impart a better sense of why the amendment was introduced, what had to be done to ensure compliance and which stakeholders were responsible.
Why COI? The conflict provisions outlined in the Code since 2004 have largely been ignored, so the amendments to the Code resulted directly from the industry’s failure to address conflicts independently. “South Africa’s compliance environment appears to be too immature for principle-based regulation,” said Hattingh. The only way to get results is to crack the whip and put more rules in place.
What should larger financial services providers do to ensure compliance? Hattingh said it was imperative to get top management to work through the COI prohibition on financial interest requirements. Management makes the final decision on how to deal with clients, who to send on incentive trips and who gets bonuses. They also have to filter the new way of doing business through the company. The COI management policy is important because non-compliance with the Code is a risk. She urged companies to avoid standardisation: “It’s very important that each business and business unit takes note of what COI means to them…”
The section of COI giving rise to the most questions is the immaterial interest provision. This clause provides that financial interest up to R1 000 per year can accrue to a provider who is a sole proprietor or a representative (for that representative’s benefit). “We’ve had people ask us whether they can give their advisers coffee and tea during an office visit,” quipped Hattingh. She suggests a measure of commonsense when tracking immaterial benefits. Clearly the COI intention isn’t to attach value to every cup of coffee or tea you provide!
Hattingh warned those who chose not to comply of the dire consequences. You’d have to avoid your competitors, whistleblowers in your own ranks, consumers – and evade the regulator’s 450 to 500 site visits each year. All the FSB has to do is crack down on a small services provider and trace non-compliance back through its supply chain. These investigations tend to take a long time to complete, but enforcement action will be taken! The idea with COI is to bring the concepts of best advice and due care and diligence to the financial services landscape. “The consumer must be protected, so if there’s anything that seems to be a conflict we’re going to clamp down on it,” said Hattingh. The good news for intermediaries is if you implement FAIS correctly, then provisions such as TCF and COI won’t impact you as much.
