By Moonstone Information Refinery

The FSCA has reconsidered its proposal to implement a minimum B-BBEE Level 4 requirement for financial institutions during Phase 2 of its strategy to promote transformation.

The Authority published its final strategy for financial sector transformation on 30 March. It also published a document setting out its responses to comments received from stakeholders following the publication of its draft strategy in February 2022.

The strategy outlines how the FSCA will promote transformation within the current legislative framework, such as the B-BBEE Act and the Financial Sector Code, pending the finalisation of the Conduct of Financial Institutions (Cofi) Bill, and how it will promote transformation once Cofi is enacted. This is when Phase 2 will start.

Cofi, which will be tabled in Parliament this year, contains proposals to strengthen the powers of the FSCA in relation to financial sector transformation. These include:

1.Making the promotion of financial sector transformation an explicit function of the FSCA;
2.Requiring all licensed financial institutions to have a transformation plan in place; and
3.Empowering the FSCA to take regulatory action against financial institutions that do not uphold the transformation commitments set out in their plans.

This article will focus on four of the issues addressed in the response document:

• Doing away with the minimum requirement of Level 4 B-BBEE status;
• How the inclusion of transformation will impact the licensing of entities;
• What actions the FSCA will take against non-compliant entities; and
• The cost of B-BBEE verification.

1. Level 4: too high or too low

The FSCA’s draft strategy proposed that all financial institutions with an annual revenue of more than R10 million should have a B-BBEE Level 4 score or have in place a transformation plan that demonstrates how they will reach this level within five years.

Some commentators argued that a “one-size-fits-all” approach will not work and that five years were insufficient for the transformation of all types of businesses, particularly Qualifying Small Financial Institutions (QSFIs).

A QSFI is an entity with total annual revenue of more than R10m but less than R50m. Any enterprise with total annual revenue of up to R10m qualifies as an Exempted Micro-Enterprise (EME). An EME is deemed to have Level 4 B- BBEE status.

QSFIs have a simple structure – for example, sole proprietorship. They typically have a team of 10 to 15 people or less, consisting of one or two key individuals, a few representatives, and administrative personnel. It would therefore be unrealistic to subject these businesses to the minimum B-BBEE Level 4 requirement and to expect them to meet some of the elements of the Financial Sector Code, particularly the elements of ownership and management control.

As a result, it was argued that QSFIs should not be subjected to the same requirements as larger businesses with a turnover of more than R10m and more than 30 employees. When determining the required B-BBEE level, the FSCA should consider other factors, such as staff turnover, business activities, and the complexity of the ownership structure, not only the business’s revenue.

On the other hand, some commentators said the proposed B-BBEE Level 4 requirement was too low, and B-BBEE Level 2 compliance should be required across the board. The minimum requirements for Level 2 B-BBEE status should include a combination of 51% black ownership and at least 50% black representation at management and senior management levels, they said.

FSCA’s ‘proportionate approach’

The FSCA said it has decided to refine its strategy and implement “a proportionate approach” to transformation instead of requiring a minimum Level 4 B-BBEE status across the board.

Its proportionate approach will include allowing for exemptions and different requirements for entities:

Below a certain turnover threshold;

• With specific ownership structures;
• With certain types of business models; and
• That have attained a specific B-BBEE level.

By removing a minimum B-BBEE Level 4 requirement, the FSCA said it will be better placed to implement a risk- based approach, focusing resources on where there is a greatest need for transformation efforts. This could include entities with a “high” B-BBEE Level rating but with poor performance in specific elements; entities that show no progress in terms of their transformation levels or targets; and entities that cannot motivate why they are unable to achieve higher levels of transformation.

A minimum B-BBEE level may still be set over time if it is deemed necessary and following consultation, the Authority said.

2. Impact of transformation during licensing

The FSCA said it will not be enforcing legislation over which is has no jurisdiction, such as the B-BBEE Act. The
FSCA’s transformation requirements will rely on provisions in the Cofi Act.

It said this in response to commentators’ arguments that the FSCA’s powers should be limited to “promoting” rather than “enforcing” transformation during the licensing process, to prevent the Authority from regulating beyond its mandate.

The FSCA answered the following questions about transformation and licensing:

How will the inclusion of transformation in the licensing process impact an entity’s ability to enter the sector and operate?

In terms of Cofi, institutions will be required to have in place transformation plans. This is likely to become a mandatory licensing requirement. Transformation plans submitted at the licensing stage will be assessed to ensure they demonstrate a commitment to the objective of transformation and the FS Code targets. Institutions will be expected to develop plans that are tailored to their specific business model. Ongoing supervision will assess the performance of financial institutions against their transformation plans.

Further guidance will be provided as licensing frameworks are developed to implement the COFI Bill. What impact will transformation plans have on already licensed institutions?
It is envisaged that once the Cofi Bill becomes law, a licence conversion process will be undertaken to move from existing sectoral licences to licences and authorisations under the Cofi Act. As part of this conversion process, licensed entities are likely to be required to submit their transformation plans to the FSCA within a specified time frame.
Details on how the new licensing framework will be phased in, including the licence conversion process, will be communicated as the Cofi Act is implemented.

What aspects of a transformation plan will be considered during the licensing process?

The FSCA will ensure that institutions’ transformation plans cover all applicable elements of the Financial Sector Code. No preference will be given to specific elements during licensing.

3. Not all actions taken against non-compliant firms will be punitive

Commentators said it was inevitable that the FSCA’s issuing of penalties for non-compliance with the Cofi Act’s transformation requirements will result in some financial institutions being unable to operate – they will have to close their doors and their staff will be unemployed.

Instead of punishing institutions for non-compliance, they proposed the FSCA provide financial institutions with incentives to transform, in line with the approach established under the B-BBEE Act.

The FSCA said where it determines that an institution has failed to meet the commitments made in its transformation plan, the Authority will be able to employ various supervisory and enforcement actions, not all of which are punitive. These range from engaging the entity and agreeing to a way forward, to issuing enforceable undertakings, issuing directives, or imposing administrative penalties.

Although the FSCA can withdraw or suspend a licence, “such an action is never taken without following due process and in full consideration of the impact that such an action would have”.

The Authority said its actions aimed at promoting transformation cannot be taken in a manner that may harm its other objectives, including enhancing and supporting the efficiency and integrity of financial markets, protecting financial customers by promoting fair treatment, and assisting in maintaining financial stability.

4. High cost of B-BBEE verification certificates

Commentators said the cost of verifying B-BBEE scorecards will be prohibitively expensive, putting a significant additional burden on small institutions.

The FSCA said the Financial Sector Code’s verification requirements for each category of entity will continue to apply. To avoid duplication and inconsistencies, the FSCA’s requirements will be similar.

Further engagement will be held within the sector and relevant agencies, to see whether prohibitive costs can be addressed.