## _cr14340

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---

### Executive summary and overall assessment
- Context and vulnerabilities
  - Financial sector operates in a challenging economic environment with one of the world’s highest unemployment and income inequality rates.
  - Slow economic growth since 2008 has aggravated unemployment; real disposable income is stagnant, and households are heavily indebted.
  - As a result:
    - Banks are increasingly exposed to credit risk.
    - Households and firms are vulnerable to a rise in interest rates.
  - Large fiscal and current account deficits, weak growth outlook, reliance of banks on money market funds (MMFs) for short-term wholesale funding, and banks’ active trading in the OTC derivatives market increase susceptibility to contagion and sudden stops of capital flows.
  - Significant concentration and interconnections, and substantial expansion of South African banks into sub-Saharan Africa, exacerbate spillover risks.
- Capitalization and supervision
  - Banks and insurers are well capitalized and profitable.
  - SARB is a proactive supervisor with a high level of compliance with international standards on effective banking supervision.
  - Overall, financial sector risks and vulnerabilities are elevated but manageable.
- Recent episode
  - African Bank placed under curatorship (August 2014); SARB’s decisive action limited contagion.
  - SARB’s proposed bail-in of senior unsecured creditors noted as a positive step toward reducing the “too big to fail premium.”

### Key FSAP recommendations (Priority, Timeframe 1–2 years)
- Twin Peaks Reform
  - Define institutional, governance and accountability arrangements for prudential and market conduct regulation, including NCR and other relevant institutions. (¶26)
  - Publish a roadmap for regulatory reform, with resource allocation, monitoring and evaluation. (¶26)
- Microprudential
  - Strengthen group-wide supervision; monitor intra-group transactions and aggregate exposures; conduct joint on-site visits. (¶30, 32, 35)
  - Clarify objectives and strengthen operational independence of all financial sector supervisors in legislation. (¶30, 32, 36)
  - Enhance regulatory requirements of CIS; introduce variable net asset valuation for MMFs; strengthen supervision of CIS managers. (¶34, 35)
  - Fully implement Solvency Assessment and Management and Treating Customers Fairly initiatives; prioritize protecting policyholder rights in legislation. (¶31)
- Macroprudential
  - Continue building a top-down stress testing framework for the banking sector and give SARB more resources for data collection and analysis. (¶39)
- Financial safety nets and crisis management
  - Introduce a resolution regime compliant with the Key Attributes and make SARB the resolution authority for all banks and SIFIs. (¶46)
  - Adopt depositor preference and introduce an ex ante funded DIS with a back-up credit line from the National Treasury (NT). (¶48)
  - Remove constraints to early intervention powers and improve legal protection for resolution officials. (¶46)
- OTC derivatives and market oversight
  - Improve data collection and surveillance of OTC derivatives. (¶40)
  - Consider establishing a local CCP with credit lines from the SARB and securities collateral at a central securities depository. (¶41)
- Competition
  - Adopt best practices on provision and disclosure of market information to retail customers and potential entrants; adopt a transparent entry and exit framework and lower entry hurdles. (¶51)

### Structural reform priorities and crisis management actions
- Upgrade crisis management and resolution framework:
  - Enhance early intervention powers of SARB and prudential regulators.
  - Introduce a resolution regime for banks and systemic NBFIs aligned with the Financial Stability Board’s Key Attributes.
  - Introduce a DIS founded on depositor preference with an ex ante fund and NT back-up credit line.
- Twin Peaks implementation needs:
  - Clear demarcation of supervisory responsibilities and accountability.
  - Effective coordination mechanisms; SARB empowered with resources and authority to collect granular data and perform regular stress testing, especially for SIFIs.
- Promote competition:
  - Reduce capital required for entry to encourage smaller banks.
  - Adopt a transparent exit framework; close gaps that favor incumbents.
  - Improve access to information on financial services to enable product comparisons.

### Financial system profile: size, structure, and funding
- Aggregate figures (exact)
  - Financial sector assets: 298 percent of GDP.
  - NBFIs hold about two thirds of financial assets.
  - Pension funds assets: 110 percent of GDP.
  - Banking assets: 112 percent of GDP.
  - Insurance assets (mostly life, long-term insurers): 64 percent of GDP.
  - Unit trusts or CISs: 42 percent of GDP.
- Banking sector structure and cross-border footprint
  - Dominated by four large banks (ABSA, FirstRand, Nedbank and Standard), Investec (mid-sized), and two smaller banks (African Bank and Capitec).
  - Close to 95 percent of banking assets are domestic.
  - Four largest banks have 46 foreign subsidiaries, of which 39 are in Africa.
  - Combined African exposure: 2 percent of banking assets (presence significant in Lesotho, Namibia and Swaziland).
- Funding and liquidity profile (exact shares)
  - Domestic deposits: 87 percent of bank funding.
  - Of deposits, 60 percent come from NBFIs and corporations with maturities of six months or less.
  - Loan to deposit ratio: above 120 percent.
  - Banks’ foreign currency liabilities: 6.5 percent of total liabilities.

### Concentration, interconnections, and market metrics
- Concentration (exact)
  - Top five banks hold 90.5 percent of banking assets.
  - Top five insurers account for 74 percent of the long-term insurance market.
  - Seven largest fund managers control 60 percent of unit trust assets.
- Market capitalization and foreign participation (exact)
  - Bond market capitalization: 57 percent of GDP.
  - Equity market capitalization: 288 percent of GDP.
  - Foreign holdings of government bonds: 34 percent of total.
  - Foreign holdings of equities: 34 percent of total.
  - Notional value of the OTC derivatives market: US$3 trillion.

### Recent macro-financial developments (selected exact figures)
- Economy projected growth in 2014: 1.4 percent.
- Unemployment rate: 25.5 percent in 2014Q2.
- Government debt: rose from 27 percent of GDP in 2008 to 46 percent of GDP in 2014.
- Current account deficits: over 5 percent of GDP.
- Household debt: peaked at 83 percent of income in 2008; 75 percent of income in 2013.
- Retail unsecured lending growth: 47 percent between 2010 and 2012, reaching 11.7 percent of total bank loans at end-2013.
- Impaired retail unsecured lending to low-income households: 18.7 percent in 2013 (up from 14.2 percent in 2011).
- Standard and Poor’s downgrade: downgraded sovereign foreign currency debt in June 2014 to one notch above speculative grade.
- African Bank: placed in curatorship in August 2014; SARB wrote down senior unsecured creditors by 10 percent.
- ROE of all banks: declined from 21 percent in 2011 to 15 percent in early 2014.
- ROE of the four largest banks: remained above 20 percent.
- Total nonperforming loan ratio: below 3 percent in 2014.
- Tier one capital ratio: rose to 13 percent in early 2014 from 12 percent in 2011.

### Risks and vulnerabilities (categorized)
- A. Credit Risks (exact shares and ratios)
  - Household loans: 44 percent of bank lending; large proportion are floating-rate mortgages.
  - 48 percent of new mortgages have LTV ratios above 80 percent.
  - 35 percent of mortgages outstanding have LTV ratios above 80 percent.
  - Lending to corporate sector: 32 percent of bank loans.
- B. Systemic Liquidity
  - Economy’s dependence on external financing makes it vulnerable to re-pricing of global risk and sudden stops.
  - Banks’ dependence on short-term wholesale funding and active OTC derivatives trading increases susceptibility to external shocks.
  - Reserve coverage remains below most EMs.
  - Capital controls limit overseas investment to 25–35 percent of assets.
- C. Concentration and Interconnectedness
  - MMFs invest more than half their assets in the largest banks through deposits and other short-term instruments.
  - Interconnections create counterparty and liquidity channels transmitting shocks across the system.
- D. Cross-Border Expansion
  - Rapid expansion into rest of Africa could introduce risks: weak supervision, weak AML/CFT compliance, less developed infrastructure, IT platform inadequacy, exposure to poor credit quality.
  - Share of assets of South African banks’ subsidiaries in local banking systems (selected exact figures):
    - Swaziland: 65 percent (29 percent of GDP).
    - Lesotho: 97 percent (47 percent of GDP).

### Stress testing: methodology and outcomes
- Banking stress tests
  - Bottom-up (BU): six banks representing 94 percent of banking assets (bank proprietary data; ST horizon 3-year 2014-2016).
  - Top-down (TD): FSAP team covered four banks with 86 percent of banking assets (supervisory data; ST horizon 5-year 2014-2018).
  - Scenarios: baseline, adverse, severely adverse (informed by IMF Global Risk Assessment Matrix).
  - Key TD findings:
    - Significant increase in PDs, especially for retail unsecured loans.
    - Credit losses on retail credit account for 2.5 percentage points of the total 4.25 percentage point decline in the CET1 ratio.
    - TD aggregate decline in CET1: 4.25 percentage points; capital ratio of three out of four banks drops below regulatory minimum.
    - TD assumptions include a 24 percent LGD for mortgage loans (implying property prices decline by 40 percent for a mortgage loan with initial LTV of 80 percent).
  - BU findings:
    - Average capital ratios fall modestly by year three: from 11.75 percent to just under 11 percent under severe stress.
    - BU tests assume potential bank actions (e.g., lower dividend payments) and use granular bank data covering domestic and foreign operations.
- Key scenario macro variables (selected excerpts from Table 2; in percent; series of values preserved)
  - Policy interest rate (REPO): historical 5.0 5.8 6.6 7.0 7.0 7.0 5.9 7.4 7.6 7.4 7.5 6.1 8.2 8.5 7.5 7.3
  - Effective lending rate: 8.8 9.7 10.5 10.9 10.9 10.9 11.9 12.5 12.5 12.9 10.2 13.0 14.0 13.4 13.7
  - GDP growth: 1.9 2.4 2.7 3.2 3.5 3.2 2.0 -1.8 -0.6 1.6 2.7 1.9 -3.9 -3.9 -1.0 2.1
  - Inflation: 5.7 5.9 5.6 5.4 5.4 5.3 6.0 7.3 5.6 4.7 5.1 6.0 8.4 6.2 4.2 4.5
  - Official unemployment rate: 24.7 24.6 24.5 24.2 23.8 23.4 24.6 24.9 25.5 25.6 25.3 24.6 25.2 26.3 26.8 26.7
  - NEER change: -13.9 -11.4 -1.8 -3.4 -3.8 -3.5 -17.9 -12.5 1.9 -0.9 -4.3 -20.0 -19.0 2.8 0.6 -4.4
  - Household debt to income ratio: 76.9 76.8 74.6 72.5 70.1 68.2 77.0 76.7 77.2 77.1 76.2 77.2 77.8 80.3 82.7 83.0
  - Property price growth: 10.0 7.2 4.5 4.6 5.8 5.5 7.3 5.0 1.3 0.6 0.0 7.2 5.3 -0.3 -2.9 -3.7
- Aggregate stress-test outcomes (summary)
  - BU: aggregate CET1 ratio falls from 11.75 percent to just under 11 percent by year three under severe stress.
  - TD: aggregate CET1 ratio declines by 4.25 percentage points under severe stress; three of four banks fall below regulatory minimums under TD assumptions.
  - Retail unsecured credit losses contribute 2.5 percentage points of the 4.25 percentage point CET1 decline in TD severe scenarios.

### Market and liquidity risk resilience; liquidity facilities (exact findings)
- Market risk
  - Multi-factor shock calibrated on GFC movements has limited impact on banks’ trading book.
  - Banking book sensitivity: downward parallel shift of rates by 200 bps reduces CET1 ratio by 32 bps.
- Liquidity stress tests (LCR and NSFR)
  - LCR of five of six banks tested is below 100 percent.
  - For some banks, LCR is below the 60 percent minimum that will become effective in 2015.
  - Aggregate liquidity shortfall occurs in less than 20 days under stress.
  - All banks can meet LCR with SARB support via the Committed Liquidity Facility (CLF).
- CLF operational details (as presented)
  - CLF available to all banks that apply at SARB discretion, capped at a maximum of 40 percent of a bank's anticipated HQLA requirement.
  - SARB charges a scaled commitment fee between 10 and 45 basis points based on bank’s usage.
  - Interest rate on drawdowns: repo rate plus 100 basis points; draw downs have maturity of 31 days.
  - Large-scale CLF use could have monetary policy implications.
- NSFR
  - NSFR of all but one bank is below 100 percent.
  - Structural constraints: small retail deposit base and limited availability of long-term funding in capital markets.
  - Potential bank responses: reduce long-term assets or offer higher rates to attract funding with maturities beyond one year.

### Insurance and corporate sector stress testing (selected exact outcomes)
- Insurance stress test (FSB semiannual framework; coverage)
  - Life insurers: median CAR coverage ratio declines from 317 percent at end-2013 to 125 percent after shock, recovering to 300 percent by end-2018.
  - Main drivers: equity shocks and default of largest banking counterparty.
  - Default of largest banking counterparty reduces average available capital by 28 and 23 percent (reported contributions).
  - Non-life insurers: median CAR coverage ratio drops from 175 percent at end-2013 to 138 percent after shock, recovering to pre-stress levels in 2015.
- Corporate sector sensitivity
  - Scenario: interest rate increase of 250 bps between 2014 and 2017; earnings decline of 33 percent in 2014–15.
  - Debt at risk (earnings less than two times interest): rises from 38 percent to 55 percent of total corporate debt.
  - Public sector corporations: interest coverage falls below 2; foreign-loans account for 44 percent of total liabilities.

### Regulatory and supervisory framework: progress and action items
- Basel III and structural reforms
  - Basel III implementation on track.
  - Domestic SIB capital requirement, conservation buffer, and countercyclical capital buffer to be phased in from 2016 when current 1 percent systemic risk charge is phased out.
  - Leverage ratio set at 4 percent.
  - Banks currently required to hold 5 percent of total liabilities in liquid assets and 2.5 percent in cash.
  - LCR will be introduced in 2015.
- Twin Peaks design and implementation priorities
  - Objective: Prudential Authority (PA) in SARB and Market Conduct Authority (MCA) in FSB.
  - Recommendations include clarifying legal/operational relationship between PA and SARB, enshrining PA CEO operational independence, addressing conglomerate supervision in law, absorbing NCR into MCA, explicit membership for CFR, and granting SARB systemic regulator information powers.
  - MoUs and operational integration should be managed to minimize transition risks; include sunset review mechanism in legislation.
- Microprudential sectoral recommendations (banking, insurance, securities)
  - Banking: strengthen group-wide supervision; begin resolution plans for systemic banks; enshrine objectives and operational independence of supervisor in law; amend laws expeditiously.
  - Insurance: formalize objectives and legal authority for group-wide supervision; fully implement SAM and TCF; strengthen resources and risk-based supervisory cycle.
  - Securities/CIS: enhance disclosure, valuation and accounting for CIS; consider converting constant NAV MMFs to variable NAV; strengthen capital and reporting for FSPs; use full enforcement powers including criminal prosecutions.

### Crisis management, resolution, and safety nets (detailed reforms)
- Resolution regime and legal changes
  - Draft Financial Services Regulation Bill assigns resolution powers to SARB but scope needs clarification—focus on deposit-taking institutions and systemic NBFIs.
  - Recommendation: enhance resolution regime with Key Attributes including transfer, bridge bank and bail-in powers, and early triggers.
  - Remove legal constraints (e.g., 30 day ex ante notices) limiting early intervention; strengthen legal protection and indemnities for resolution officials.
  - Judicial review provisions that can reverse SARB decisions should be removed or limited to avoid hindering resolution actions.
- Liquidity assistance and SARB arrangements
  - Introduce solvency test such that ELA to potentially insolvent firms only with government indemnity.
  - Replace collateral prohibitions with a generic prudent collateral policy requirement.
  - Assess liquidity needs of systemic NBFIs (CCPs) and define ELA eligibility publicly.
  - Adjust CLF fee structure periodically to incentivize balance sheet restructuring.
- Deposit insurance and depositor preference
  - An ex ante-funded DIS complemented by depositor preference (DP) is desirable.
  - Ex ante fund with NT backup credit line can target payouts for a number of small and medium banks; fund can support resolution subject to strict least cost test.
  - DP would increase recoveries and facilitate resolution but does not substitute for quick payout speed of DIS.

### OTC derivatives reform and CCP considerations
- Reforms under Financial Markets Act and bank regulations reflect Basel III.
- Implementation considerations
  - Enhance surveillance: collect comprehensive OTC derivatives positions of NBFIs and corporates, not just banks.
  - Increase capital and margining consistency; current margining practices uneven.
  - Consider establishing a local CCP:
    - Benefits: local supervisory oversight; clearing/collateral exchange compatible with capital controls; supports smaller local clearing providers.
    - Trade-offs: reduced netting opportunities; lower capacity to manage defaults.
    - Risk management for CCPs: strong risk management, reduce dependency on local banks via SARB credit lines, place collateral at a recognized CSD.

### Competition and market access
- Entry and exit barriers
  - Minimum capital requirements (MCR) for banks are between 4 and 100 times higher than in other EMs (Figure 9 cited).
  - Access to clearance and payments biased against new entrants; exits are limited.
- Policy measures to promote competition (selected)
  - Lower entry hurdles with stringent fit and proper tests.
  - Increase market information and transparent entry/exit framework.
  - Adopt Basel Committee’s point-of-sale information recommendations.
  - For FMIs, follow CPSS-IOSCO principle 23 on disclosure of rules, procedures and market data.
  - Remove interest rate caps and require transparency for consumer comparisons.
  - If MCA is not unified with NCR, ensure close working relationships with Competition Commission and checks and balances.

### AML/CFT: progress and remaining priorities
- Progress since 2008: shift to risk-based approach in banking supervision; planned expansion to other financial sector AML/CFT measures.
- Supporting actions needed
  - Amend legal framework; conduct a national risk assessment (NRA); communicate supervisory expectations; provide practical guidance; allocate supervisory resources.
- Capacity gaps
  - Enhanced capacity needed to pursue complex ML cases.
  - Customer due diligence measures need strengthening to identify and verify beneficial owners.
  - Authorities should have timely access to accurate beneficial ownership information.
- Priority
  - Conducting an AML/CFT NRA should be a priority.

### African Bank intervention (August 10, 2014) — key figures and actions (exact)
- African Bank context
  - Sixth largest bank, accounting for about 1.5 percent of banking system assets.
  - Funded primarily by domestic and externally issued wholesale debt.
- Resolution and restructuring plan (exact figures)
  - “Good bank” to comprise retail deposits at face value (of less than 1 percent of total liabilities), senior debt and wholesale deposits written down to 90 percent of their face value, and new capital of approximately ZAR 10 billion, underwritten by consortium of major private banks and Public Investment Corporation.
  - Approximately ZAR 26 billion of performing loans to be transferred to the “good bank.”
  - Impaired assets and subordinated claims remain in African Bank under curatorship.
  - SARB announced injection of ZAR 7 billion (0.2 percent of GDP) to finance the resolution, taking security of impaired loans with book value ZAR 17 billion that will not transfer to the “good bank.”
  - Government provided a R7 billion backstop to SARB; authorities indicated it is unlikely SARB will draw on this facility; no costs to taxpayer expected.
- Operational recommendations
  - Ensure “good bank” well capitalized and liquid.
  - SARB to conduct due diligence on impaired assets used as collateral and revise valuations if necessary.
  - SARB must ensure efficient management and servicing of loans with appointment and incentivization of private sector expertise; decisions to be on arm’s length, commercial basis.

### Financial soundness indicators and selected tables (selected exact series)
- Capital adequacy (Risk-weighted capital adequacy ratio)
  - 2008: 13.0 | 2009: 14.1 | 2010: 14.9 | 2011: 15.0 | 2012: 15.8 | 2013: 15.6 | 2014 Q2: 14.6
- Tier 1 capital (percent)
  - 2008: 10.2 | 2009: 11.0 | 2010: 11.8 | 2011: 12.2 | 2012: 12.6 | 2013: 14.1 | 2014 Q2: 13.5
- Nonperforming loans (percent of outstanding loans)
  - 2008: 3.9 | 2009: 5.9 | 2010: 5.8 | 2011: 4.7 | 2012: 4.1 | 2013: 3.6 | 2014 Q2: 3.4
- Return on equity (percent)
  - 2008: 26.9 | 2009: 18.0 | 2010: 18.2 | 2011: 21.0 | 2012: 17.5 | 2013: 18.6 | 2014 Q2: 17.9
- Liquid assets (percent of total assets)
  - 2008: 16.8 | 2009: 15.8 | 2010: 16.0 | 2011: 15.7 | 2012: 16.2 | 2013: 16.6 | 2014 Q2: 17.9
- Household debt (percent of disposable income)
  - 2008: 82.4 | 2009: 81.5 | 2010: 78.6 | 2011: 78.6 | 2012: 75.4 | 2013: 76.3 | 2014 Q2: 74.5

### Risk Assessment Matrix — key threats, likelihood, and financial stability impacts (selected)
- 1. Surge in market volatility and higher-than-expected increases in interest rates
  - Overall level of concern: High
  - Likelihood (1–3 years): High
  - Expected impacts include deterioration in household debt quality, market price changes and spillovers, potential fall in growth from capital inflow reversal, and weaker external position.
- 2. Protracted slower growth in advanced and emerging economies
  - Overall level of concern: High
  - Likelihood (1–3 years): High
  - Expected impacts: severe recession risk for South Africa, higher unsecured credit losses, pressure on sovereign rating and funding costs.
- 3. Liquidity shortfall in banking system
  - Overall level of concern: Medium
  - Likelihood (1–3 years): Medium
  - Expected impacts: reliance on short-term wholesale funding; five of six banks maintain LCR and NSFR lower than 100 percent.
- 4. Stress in certain financial institutions spilling over
  - Overall level of concern: Medium
  - Likelihood (1–3 years): Medium
  - Expected impacts: high interconnectedness could convert idiosyncratic shocks into systemic events; failure of five largest financial borrowers causes CET1 to decline by 1.9 percentage points in ST.
- 5. Losses due to cross-border expansions
  - Overall level of concern: Medium
  - Likelihood (1–3 years): Medium
  - Expected impacts: tripling of claims on Sub-Saharan Africa over five years; combined African exposure 2 percent of banking assets but significant host-market presence.

*International Monetary Fund — Selected excerpts from the Financial Sector Assessment (South Africa).*

### EXECUTIVE SUMMARY AND OVERALL ASSESSMENT  __________________________________________  7

### EXECUTIVE SUMMARY AND OVERALL ASSESSMENT

### Overall assessment and context
- South Africa’s financial sector operates in a challenging economic environment with one of the world’s highest unemployment and income inequality rates.
- Slow economic growth since 2008 has aggravated unemployment; real disposable income is stagnant, and households are heavily indebted.
- As a result:
  - Banks are increasingly exposed to credit risk.
  - Households and firms are vulnerable to a rise in interest rates.
- The large fiscal and current account deficits, a weak growth outlook, reliance of banks on money market funds (MMFs) for short-term wholesale funding, and banks’ active trading in the over-the-counter (OTC) derivatives market increase susceptibility to contagion and sudden stops of capital flows.
- Significant concentration and interconnections in the financial system, and substantial expansion of South African banks into sub-Saharan Africa, exacerbate spillover risks.

### Recent episode: African Bank (August 2014)
- African Bank, a boutique lender catering mainly to low-income households, was placed under curatorship after record losses from unsecured lending.
- Although small in size, African Bank’s problems underscored that:
  - Asset quality can deteriorate quickly in a weak economy.
  - Even small institutions can entail systemic risk due to high interconnectedness.
- The South African Reserve Bank (SARB) placed African Bank under curatorship; the SARB’s decisive action limited contagion.
- SARB’s proposed bail-in of senior unsecured creditors to share in the burden of resolution is noted as a positive step toward reducing the “too big to fail premium” for large banks.

### Capitalization and regulatory strengths
- Banks and insurers are well capitalized and profitable.
- SARB is a proactive supervisor with a high level of compliance with international standards on effective banking supervision.
- Overall, financial sector risks and vulnerabilities are elevated but manageable.

### Stress test findings (summary)
- Stress tests confirm capital resiliency of banks and insurance companies to severe shocks but reveal vulnerability to liquidity shortfalls.
- Some banks have difficulty meeting Basel’s requirement to hold enough High Quality Liquid Assets (HQLA) to survive a stress scenario lasting 30 days without assistance from the SARB.
- Banks face larger challenges meeting a more stringent requirement to hold a minimum amount of stable funding over a one year horizon.
- Although phased implementation of these requirements is planned, the African Bank case highlights the importance of ensuring large banks maintain adequate liquidity.

### Policy implications (high-level)
- Given significant downside risks to the economy, strong regulation and supervision are essential to ensure financial sector resilience.
- Remaining gaps in the supervisory and regulatory framework should be closed.
- The Twin Peaks reform presents an opportunity to strengthen responsibilities, accountability, and coordination among supervisors.

---

### Key FSAP recommendations (Priority, Timeframe 1–2 years)
- Twin Peaks Reform
  - Define clear and comprehensive institutional, governance and accountability arrangements for prudential and market conduct regulation, including NCR and other relevant institutions. (¶26)
  - Publish a roadmap for regulatory reform, with adequate resource allocation, monitoring and evaluation, to carefully implement the move to Twin Peaks and minimize transition risks. (¶26)
- Microprudential
  - Strengthen group-wide supervision, focusing on credit and interconnectedness risks; monitor intra-group transactions and aggregate exposures, and conduct joint on-site visits. (¶30, 32, 35)
  - Clarify objectives and strengthen the operational independence of all financial sector supervisors in the relevant legislation in line with international standards. (¶30, 32, 36)
  - Enhance regulatory requirements of CIS, particularly for disclosure, valuation and accounting, introduce variable net asset valuation for MMFs, and strengthen the supervision of CIS managers. (¶34, 35)
  - Fully implement Solvency Assessment and Management and Treating Customers Fairly initiatives; give high priority in legislation to protecting policyholder rights and entitlements. (¶31)
- Macroprudential
  - Continue building a top-down ST framework for the banking sector and give SARB more resources for data collection and analysis. (¶39)
- Financial Safety Nets
  - Introduce a resolution regime compliant with the Key Attributes for, and make the SARB the resolution authority of, all banks and SIFIs. (¶46)
  - Adopt depositor preference and introduce an ex ante funded DIS, with a back-up credit line from the National Treasury (NT). (¶48)
  - Remove constraints to early intervention powers and improve legal protection for resolution officials. (¶46)
- OTC Derivatives Market Reforms and Oversight
  - Improve data collection of OTC derivatives and enhance surveillance of the OTC derivatives market. (¶40)
  - Consider establishing a local CCP, with credit lines from the SARB and securities collateral placed at a central securities depository to reduce dependency on local banks. (¶41)
- Competition
  - Adopt international best practices on provision and disclosure of market information to retail customers and to potential entrants into the payments and clearance systems. (¶51)
  - Adopt a transparent entry and exit framework, and lower entry hurdles to the financial system. (¶51)

---

### Structural reform priorities and crisis management
- Upgrade crisis management and resolution framework:
  - Enhance early intervention powers of the SARB and other prudential regulators.
  - Introduce a resolution regime for banks and systemic nonbank financial institutions (NBFIs) aligned with the Financial Stability Board’s Key Attributes of Effective Resolution (KA).
  - Introduce a Deposit Insurance Scheme (DIS) founded on depositor preference (DP), with a carefully calibrated ex ante fund and a back-up credit line from the National Treasury (NT).
- Twin Peaks implementation needs:
  - Clear demarcation of supervisory responsibilities and accountability.
  - Effective coordination mechanisms.
  - SARB should be empowered with resources and authority to collect granular data and perform regular stress testing, especially for systemically important financial institutions.
- Promote competition to improve efficiency and access:
  - Reduce capital required for entry to encourage establishment of smaller banks.
  - Adopt a transparent exit framework.
  - Close regulatory and supervisory gaps that favor incumbents.
  - Improve access to information on financial services to help users compare products on terms, price, risks and benefits.
  - Balance financial stability concerns with the objective of reducing concentration.

---

### FINANCIAL SYSTEM PROFILE

### Size and structure
- Financial sector assets amount to 298 percent of GDP.
- NBFIs hold about two thirds of financial assets.
- Specific asset shares:
  - Pension funds assets: 110 percent of GDP.
  - Banking assets: 112 percent of GDP.
  - Insurance assets (mostly life): 64 percent of GDP (long-term insurers).
  - Unit trusts or CISs: 42 percent of GDP.

### Banking system composition and cross-border footprint
- System dominated by four large banks (ABSA, FirstRand, Nedbank and Standard), a mid-sized investment bank (Investec), and two smaller banks (African Bank and Capitec) specializing in unsecured lending to low income households.
- Close to 95 percent of banking assets are domestic.
- The four largest banks have 46 foreign subsidiaries, of which 39 are in Africa.
- Combined African exposure accounts for 2 percent of banking assets, though presence is significant in some host countries (e.g., Lesotho, Namibia and Swaziland).

### Funding profile and liquidity
- Most bank liabilities are domestic, short-term, and wholesale.
- Domestic deposits are the largest source of funding: 87 percent of bank funding.
- Of deposits, 60 percent come from NBFIs and corporations with maturities of six months or less.
- Loan to deposit ratio is above 120 percent.
- Banks’ foreign currency liabilities are 6.5 percent of total liabilities.

*Source: EXECUTIVE SUMMARY AND OVERALL ASSESSMENT — _cr14340*

### 4.      The financial sector has a high degree of concentration and interconnectedness. The

### 4.      The financial sector has a high degree of concentration and interconnectedness.

### Overview
- Top five banks hold 90.5 percent of banking assets.
- Top five insurers account for 74 percent of the long-term insurance market.
- The seven largest fund managers control 60 percent of unit trust assets.
- All major banks are affiliated with insurance companies through holding companies or direct ownership.
- Bank-affiliated insurers underwrite a substantial proportion of private pension assets.
- Some banks own fund managers that offer unit trusts.
- There are substantial levels of related party transactions within financial groups.
- This concentrated structure gives major financial institutions significant pricing power and enables them to achieve returns on equity and assets higher than in more competitive economies.

### Market size, liquidity, and foreign participation
- Market capitalization of the bond market: 57 percent of GDP.
- Market capitalization of the equity market: 288 percent of GDP.
- Foreign holdings of government bonds: 34 percent of the total.
- Foreign holdings of equities: 34 percent of the total.
- Notional value of the OTC derivatives market: US$3 trillion.
- The rand is traded as a proxy currency for EM risk and has a well-developed presence in London.

### Recent developments (selected findings and statistics)
- Economy projected growth in 2014: 1.4 percent.
- Unemployment rate: 25.5 percent in 2014Q2.
- Government debt: rose from 27 percent of GDP in 2008 to 46 percent of GDP in 2014.
- Current account deficits: over 5 percent of GDP.
- Household debt peaked at 83 percent of income in 2008; 75 percent of income in 2013.
- House price inflation: moderated from 20–30 percent (2003–2006) to 5–10 percent in 2013.
- Private sector credit growth slowed sharply in recent years but household debt remained high.
- Public sector corporate borrowing raised total corporate debt to about 47 percent of GDP.
- Retail unsecured lending grew 47 percent between 2010 and 2012, reaching 11.7 percent of total bank loans at end-2013.
- Impaired retail unsecured lending to low-income households: 18.7 percent in 2013 (up from 14.2 percent in 2011).
- In June 2014, Standard and Poor’s downgraded South Africa’s sovereign foreign currency debt to one notch above speculative grade.
- African Bank placed in curatorship in August 2014; SARB wrote down senior unsecured creditors by 10 percent.
- The ROE of all banks declined from 21 percent in 2011 to 15 percent in early 2014.
- ROE of the four largest banks remained above 20 percent.
- Total nonperforming loan ratio: below 3 percent in 2014.
- Tier one capital ratio: rose to 13 percent in early 2014 from 12 percent in 2011.

### Contagion and interconnections
- Contagion from African Bank failure was limited; SARB intervened and some MMFs “broke the buck.”
- African Bank’s debt accounted for 1.3 percent of the assets held by the 43 MMFs; at least 10 MMFs “broke the buck.”
- Vulnerability of financial institutions to contagion risk remained low throughout the African Bank episode.
- NBFIs hold substantial assets in the four largest banks, partly through MMFs which invest more than half their assets in the largest banks through deposits and other short-term instruments.
- Such holdings expose NBFIs to counterparty risks and banks to liquidity risks.
- A bank failure could significantly impact asset quality of affiliated NBFIs; a sudden large withdrawal from NBFIs could cause liquidity stress for banks.

### Risks and vulnerabilities
A. Credit Risks
- Household loans account for 44 percent of bank lending; a large proportion are floating-rate mortgages.
- 48 percent of new mortgages have LTV ratios above 80 percent.
- 35 percent of mortgages outstanding have LTV ratios above 80 percent.
- Lending to the corporate sector accounts for 32 percent of bank loans.
- Public sector corporations are more indebted and vulnerable to interest rate and exchange rate shocks, though required to hedge currency and interest rate risks.

B. Systemic Liquidity
- The economy’s dependence on external financing makes it vulnerable to re-pricing of global risk and sudden stops of capital inflows.
- Banks do not rely heavily on external funding, but capital inflows affect domestic funding pricing.
- Dependence of large banks on short-term wholesale funding and active trading in the OTC derivatives market increases susceptibility to external shocks and global re-pricing of risk.
- Reserve coverage remains below most EMs.
- Capital controls limit overseas investment of financial and nonfinancial institutions to 25–35 percent of their assets.

C. Concentration and Interconnectedness
- Substantial interconnections could amplify risks between banks and NBFIs.
- MMFs invest more than half their assets in the largest banks through deposits and other short-term instruments.
- Interconnections create counterparty and liquidity channels that can transmit shocks across the financial system.

D. Cross-Border Expansion
- Rapid expansion of banks into the rest of Africa could introduce new risks: weak supervision, weak AML/CFT compliance, less developed infrastructure, IT platform inadequacy, and exposure to banks with poor credit quality.
- Share of assets of South African banks’ subsidiaries in local banking systems of rand-using countries:
  - Swaziland: 65 percent (29 percent of GDP).
  - Lesotho: 97 percent (47 percent of GDP).
- South African banks also have sizable presence in Botswana, Seychelles, Uganda, and Zambia.
- Rising trade linkages could amplify commodity price impacts and expose South Africa to negative spillbacks from these economies.

### Stress testing resiliency
A. Banking Stress Tests
- Bottom-up (BU) analysis conducted by six individual banks representing 94 percent of banking assets.
- Top-down (TD) analysis by the FSAP team covered four banks with 86 percent of banking assets.
- Tests considered baseline, adverse, and severely adverse scenarios informed by the IMF’s Global Risk Assessment Matrix.
- Since tests were conducted, the baseline macroeconomic scenario has become considerably worse.
- TD tests show a significant increase in PDs, especially for retail unsecured loans.
- In TD scenarios, credit losses on retail credit account for 2.5 percentage points of the total 4.25 percentage point decline in the Common Equity Tier 1 (CET1) ratio.
- BU tests suggest average capital ratios fall modestly by year three: from 11.75 percent to just under 11 percent.
- TD tests show a larger impact: drop in the capital ratio of 4.25 percentage points; capital ratio of three out of four banks drops below the regulatory minimum.
- TD assumptions include a 24 percent LGD for mortgage loans (implying property prices decline by 40 percent for a mortgage loan with an initial LTV of 80 percent).
- The larger impact in the TD ST reflects more stringent assumptions: higher PDs and LGDs, larger credit exposures and RWAs, and lower net income and retained earnings than in BU STs.
- BU STs allow for bank actions (e.g., lower dividend payments) and use granular bank data, covering domestic and foreign operations; TD ST covers local operations only.

### Key scenario macro variables (selected excerpts from Table 2; in percent)
- Policy interest rate (REPO): historical 5.0 5.8 6.6 7.0 7.0 7.0 5.9 7.4 7.6 7.4 7.5 6.1 8.2 8.5 7.5 7.3
- Effective lending rate: 8.8 9.7 10.5 10.9 10.9 10.9 11.9 12.5 12.5 12.9 10.2 13.0 14.0 13.4 13.7
- GDP growth: 1.9 2.4 2.7 3.2 3.5 3.2 2.0 -1.8 -0.6 1.6 2.7 1.9 -3.9 -3.9 -1.0 2.1
- Inflation: 5.7 5.9 5.6 5.4 5.4 5.3 6.0 7.3 5.6 4.7 5.1 6.0 8.4 6.2 4.2 4.5
- Official unemployment rate: 24.7 24.6 24.5 24.2 23.8 23.4 24.6 24.9 25.5 25.6 25.3 24.6 25.2 26.3 26.8 26.7
- NEER change: -13.9 -11.4 -1.8 -3.4 -3.8 -3.5 -17.9 -12.5 1.9 -0.9 -4.3 -20.0 -19.0 2.8 0.6 -4.4
- Household debt to income ratio: 76.9 76.8 74.6 72.5 70.1 68.2 77.0 76.7 77.2 77.1 76.2 77.2 77.8 80.3 82.7 83.0
- Property price growth: 10.0 7.2 4.5 4.6 5.8 5.5 7.3 5.0 1.3 0.6 0.0 7.2 5.3 -0.3 -2.9 -3.7

### Aggregate stress-test outcomes (summary)
- BU: aggregate CET1 ratio falls modestly from 11.75 percent to just under 11 percent by year three under severe stress.
- TD: aggregate CET1 ratio declines by 4.25 percentage points under severe stress; three of four banks fall below regulatory minimums under TD assumptions.
- Retail unsecured credit losses are a large contributor to CET1 declines in TD severe scenarios (2.5 percentage points of the 4.25 percentage point decline).

*International Monetary Fund — Selected excerpts from the Financial Sector Assessment (South Africa).*

### 18.      Banks also appear to be resilient to market risk in both the trading and the banking

### _cr14340 - 18.      Banks also appear to be resilient to market risk in both the trading and the banking

### Market risk resilience (trading and banking book)
- Multi-factor shock calibrated on the size of market movements during the GFC has a limited impact on banks’ trading book (sensitivity analysis similar to the 2013 U.S. CCAR exercise).
- Banking book sensitivity:
  - A downward parallel shift of rates by 200 bps would reduce the CET1 ratio by only 32 bps.
  - Impact of a compressed spread between the prime-rate and the Johannesburg Interbank Average Rate (JIBAR), which could cause imperfect hedging and reduce net interest income, appears to be negligible.

### Liquidity stress tests (LCR and NSFR)
- Tests use Basel’s liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) as the regulatory metrics.
- The liquidity risk from withdrawals of unsecured funding by related parties is assessed in the LCR with a 100 percent runoff rate.
- Key findings:
  - The LCR of five of the six banks tested is below 100 percent.
  - For some banks, the LCR is below the 60 percent minimum that will become effective in 2015.
  - In aggregate, banks experience a liquidity shortfall in less than 20 days, reflecting dependence on short-term wholesale funding and limited availability of HQLA.
  - All banks are able to meet the LCR with support from the SARB in the form of a Committed Liquidity Facility (CLF).
- CLF operational details (as presented):
  - The CLF will be available to all banks that apply at the discretion of the SARB, capped at a maximum of 40 percent of a bank's anticipated HQLA requirement.
  - The SARB will charge a scaled commitment fee between 10 and 45 basis points based on each bank’s usage of the facility.
  - The interest rate will be the repo rate plus 100 basis points and draw downs will have a maturity of 31 days.
  - Large-scale use of the CLF could have monetary policy implications that the SARB will need to address.
- NSFR findings:
  - The NSFR of all but one bank is below 100 percent.
  - Structural constraints: small retail deposit base and limited availability of long-term funding in the capital markets make it difficult for banks to meet the NSFR before it becomes effective in 2018.
  - Potential bank responses: reduce long-term assets to meet the NSFR, or offer higher interest rates to attract funding with maturities beyond one year.

### Insurance stress test (FSB semiannual framework)
- Coverage: five life insurers and four non-life insurers with 70 and 50 percent, respectively, of market share.
- Scenario design:
  - Equity shock of 50 percent.
  - Increase in interest rate by a factor of 1.5.
  - All shocks occur simultaneously at the beginning of the stress-test horizon.
  - Companies report on a solo basis; capital adequacy requirements (CAR) calculated under the current prudential solvency regime.
- Life insurers:
  - Median CAR coverage ratio declines from 317 percent at end-2013 to 125 percent after the shock, but recovers to 300 percent by end-2018, driven mainly by operating profits.
  - Main drivers of deterioration: equity shocks and the default of their largest banking counterparty.
  - The default of the largest banking counterparty reduces average available capital by 28 and 23 percent (text indicates two figures—these are the reported contributions to the overall stress).
  - Shocks can be mitigated by passing on investment losses to policyholders.
- Non-life insurers:
  - Median CAR coverage ratio drops from 175 percent at end-2013 to 138 percent after the shock, but recovers to pre-stress levels in 2015.
  - Decline driven by equity shock and bank default.
  - Additional sensitivity analysis of catastrophe risks indicates a limited effect due to wide-ranging reinsurance coverage with foreign reinsurers.
  - Main catastrophe considered: a major earthquake in the Johannesburg region—low probability but potentially very high claims.

### Corporate sector stress test (sensitivity analysis)
- Scenario:
  - Shock to borrowing costs and earnings: interest rate increase commensurate with the forward rate curve and an earnings decline similar to that during the GFC.
  - Interest rate increase used: 250 bps between 2014 and 2017.
  - Earnings decline used: 33 percent in 2014–15.
- Results:
  - Debt at risk—debt of firms with earnings less than two times the interest coverage—rises from 38 percent to 55 percent of total corporate debt.
  - Private firms fare reasonably well.
  - Interest coverage ratio of public sector corporations falls below 2, reflecting weaker starting positions including lower profitability, reliance on wholesale debt financing and foreign-loans (44 percent of total liabilities).
  - Note: public sector corporations are required to hedge foreign currency, interest rates, and commodity price exposures; further deterioration in the sovereign credit rating could increase their cost of funding and hedging.

### Structural reform to enhance resiliency (progress and planned measures)
- Progress since prior assessments:
  - Good progress addressing gaps identified in the 2008 FSAP and 2010 Standards Assessment.
  - Basel III implementation is on track.
- Capital and liquidity regime highlights:
  - A domestic systemically important bank capital requirement, conservation buffer, and countercyclical capital buffer will be phased in from 2016 when the current 1 percent systemic risk charge is phased out.
  - The leverage ratio will be kept at 4 percent.
  - Banks are currently required to hold 5 percent of total liabilities in liquid assets and 2.5 percent in cash.
  - The LCR will be introduced in 2015.

### Twin Peaks regulatory reform: design and implementation priorities
- Objective: adopt a Twin Peaks regulatory architecture with a Prudential Authority (PA) and a Market Conduct Authority (MCA) similar to the UK and Australian models.
- Design and implementation principles:
  - Build on strengths of current supervision; institutional and governance arrangements should promote operational autonomy while keeping supervisors accountable.
  - Allocate microprudential supervisory responsibilities according to relative strengths and capacity of each supervisory agency commensurate with risks of financial institutions.
  - Scope of conduct regulation should be comprehensive and consolidated to avoid duplication and multiple regulatory layers.
  - Cooperation and coordination among supervisors needed to minimize overlaps, gaps, and inconsistencies.
- Specific recommendations:
  - The legal and operational relationship between the PA and the SARB as well as the operational independence of the PA’s CEO should be made clear in the draft legislation.
  - Microprudential supervision of financial conglomerates should be addressed specifically in the law.
  - The NCR and other financial sector conduct supervisors and financial customer protection agencies should be absorbed into the MCA.
  - Legislation should provide explicitly for the agencies expected to be members of the proposed Council of Financial Regulators (CFR).
  - Membership of the Financial Stability Oversight Committee (FSOC) should be expanded to include the NCR while it is a separate entity.
  - Given the proposal to vest responsibility for financial stability in the SARB, the FSOC should be an advisory body.
  - The power to obtain necessary information from other agencies and financial institutions as a systemic regulator should be given to the SARB.
  - Operational issues such as integration of staff and information systems should be managed carefully to minimize transition risks.
  - Memoranda of Understanding (MoU) among the SARB, PA, and MCA should set out the nature and extent of cooperation between them.
  - A mechanism for a periodic sunset review of the framework should be included in the legislation.

### Microprudential framework: sectoral assessments and recommendations
- General:
  - Regulatory and supervisory frameworks for banking, insurance and securities are broadly sound with room for improvement.
Banking
- Strengths:
  - High level of compliance with the Basel Core Principles (BCP) for Effective Banking Supervision.
  - Supervisory regime based on strong relationships with bank Boards, senior management, and banks’ internal and external auditors, supported by intensive qualitative and quantitative analyses.
  - BSD has increased supervisory staff to include risk specialists and additional on-site inspectors; cooperation with domestic and foreign supervisors has strengthened.
- Areas for improvement:
  - Registrar’s powers to suspend a bank’s activities without delay are still limited.
  - Work on resolution plans for systemic banks has yet to begin.
  - Cross-border recovery and resolution planning needs strengthening.
  - Need for more intensive group-wide supervision, including stress testing, to monitor and manage risks from non-banking or parent activities of a financial group.
  - Objectives and operational independence of the supervisor should be enshrined in legislation; conditions for the Minister’s intervention should be clarified and limited.
  - Amendments to laws and regulations in these areas should be made as soon as possible.
Insurance
- Strengths and reforms:
  - Authorities updating and formalizing the regulatory and supervisory regime to reflect international best practices.
  - Key initiatives: formal group supervision framework; a risk-based Solvency Assessment and Management (SAM) regime; Treating Customers Fairly (TCF) conduct of business supervision.
- Areas for improvement:
  - Increase intensity and effectiveness of risk-based supervision, including more intensive on-site visits proportionate to risk profiles and joint visits with the SARB to financial conglomerates.
  - Group supervision should cover all insurance groups with holistic off-site monitoring of intra-group transactions and aggregate group exposures.
  - FSB should develop a risk-based supervisory cycle to cover the large number of financial services providers (FSPs) and adopt a more structured surveillance framework that considers cross-sectoral inter-linkages and system-wide market conduct issues.
  - Include conduct risks in combined risk assessment summary documentation.
  - Specific recommendations:
    - Formalize objectives for insurance supervision and legal authority for group-wide supervision in legislation.
    - Strengthen operational independence to minimize undue political or industry interference.
    - Review the adequacy of supervisory resources and augment skill sets in light of current and impending regulatory initiatives.
    - Continue positive engagement with domestic and international counterparts for effective supervisory cooperation.
Securities
- Strengths:
  - Implementation of IOSCO Principles is satisfactory in many areas.
  - Robust legal framework with broad supervisory, investigative and enforcement powers; arrangements for on-site and off-site monitoring; extensive powers to cooperate with domestic and foreign counterparts.
  - High accounting and auditing standards and disclosure regime for listed companies; market infrastructure robust for current largely domestic direct market participants.
- Areas for improvement:
  - Securities regulatory structure is complex and divided across several authorities with differing mandates, resources, and reporting lines.
  - Supervision within the FSB is divided on a sectoral basis that may not reflect how some important market participants conduct business.
  - Potential for gaps and duplication to remain under the Twin Peaks structure where responsibilities continue to be shared; ensure common understanding among FSB, SARB and JSE of scope, depth, and focus of supervision.
  - Need for more uniform scope of regulation and intensity of supervision across sectors:
    - CIS framework is less comprehensive and intrusive than other areas.
    - Disclosure regime for unlisted companies and CIS has substantive gaps; CIS valuation and accounting standards need strengthening.
    - Given risks with constant NAV MMFs, the FSB should consider requiring them to convert to variable NAV funds.
    - Capital and reporting requirements for FSPs should be strengthened.
    - The FSB should use all available authority, including pursuing more criminal prosecutions, for enforcement.

*Source: _cr14340 - 18.      Banks also appear to be resilient to market risk in both the trading and the banking*

### 36.      Certain aspects of the FSB’s governance structure raise concerns about its

### _cr14340 - 36.      Certain aspects of the FSB’s governance structure raise concerns about its

### Governance and Independence
- Presence of industry members on certain Board Committees and the authority of the MoF to remove a Board or Executive Committee member for reasons other than misconduct or incompetence may be perceived as a threat to the FSB’s independence.
- No indication of any interference with the FSB’s day-to-day operations.
- Government recognizes the need for greater regulatory independence and reflects this in the governance models in the proposed Twin Peaks legislation.
- The independence of the IRBA should also be strengthened.

### Macroprudential Framework
- The SARB plays a key role in the evolving macroprudential framework.
- Current mandate: SARB has an implicit mandate for financial stability provided in a government letter in February 2010; the letter did not include specific powers, accountability and coordination mechanisms, which are addressed in the proposed Twin Peaks legislation.
- Essential requirement: The new framework must have an effective mechanism for coordination within and between regulatory agencies.
- Macroprudential toolkit described as adequate and consisting of:
  - capital instruments;
  - liquidity instruments;
  - asset-related instruments, such as the countercyclical buffer, reserve requirements, and LTV ratios.
- These instruments can be applied as an add-on to minimum prudential regulatory requirements.
- SARB conducts systemic risk analysis in its regular Financial Stability Review, which provides the analytical foundation for using the toolkit.
- Resource and capability recommendations for the SARB:
  - More resources to carry out its function as a systemic regulator.
  - Authority to collect more granular data to facilitate use of macroprudential instruments.
  - Capability to monitor systemic risk by performing regular system-wide stress tests, with special attention to systemically important financial institutions.
  - Increased expertise on the importance of NBFIs and the role of financial markets, complemented by strengthened cooperation with the MCA.
  - Adequate resources are imperative for the SARB to effectively perform these additional responsibilities.

### Derivatives Markets Reform
- OTC derivatives market reforms are implemented through the Financial Markets Act (FMA) and new regulations for banks, reflecting the Basel III capital requirements.
- Considerations in implementing reforms:
  - Enhancing surveillance of OTC derivatives activities: need for more comprehensive information on OTC derivatives transactions and positions of NBFIs and corporate users, in addition to banks.
  - Increasing capital and margining requirements: margining practices are uneven and could subject participants to losses following a failure of one or more counterparties.
  - Avoiding unintended consequences of tighter regulation: tighter regulations may increase cost and reduce hedging, exposing NBFIs and corporates to exchange rate and interest rate volatility.
- Consideration of establishing a local CCP for OTC derivatives:
  - Benefits: enables local supervisory oversight; ability to clear and exchange collateral without conflict with South Africa’s capital controls; may support smaller players in providing clearing services.
  - Trade-offs: netting opportunities will be reduced; local CCP will have less capacity to manage a default because of a lower number of surviving clearing members.
  - If adopted, regulation needed to ensure a level playing field between the local and global CCPs, especially regarding timing of, and exemptions to, regulations (e.g., implementing initial margin requirements).
  - Risk management recommendations for local CCPs (and existing CCP for exchange-traded derivatives):
    - Strong risk management;
    - Reduce dependency on local banks by pursuing credit lines at the SARB;
    - Place collateral at a recognized central securities depository (CSD).

### Crisis Management and Bank Resolution
- Resolution regime focus: should concentrate on deposit-taking institutions and systemic NBFIs.
- Draft Financial Services Regulation Bill assigns resolution powers to the SARB, but scope of the proposed resolution regime needs clarification:
  - It should focus on deposit-taking institutions and NBFIs deemed systemic.
  - Non-deposit taking institutions whose failure would not be systemic should be resolved by their lead regulator.
  - This decision must consider wider financial and economic circumstances at that point in time.
- Cooperation and coordination mechanisms:
  - Existing mechanisms are effective but can be improved.
  - Proposed FSOC and CFR will strengthen regulatory cooperation and coordination for crisis management.
  - Role of the existing Financial Sector Contingency Forum (FSCF) should be reviewed to minimize duplication with mandates of FSOC and CFR.
  - MoUs with foreign authorities for cross-border banks pertaining only to supervision should be expanded to cover resolution and crisis management, including mechanisms for information exchange, decision-making powers and burden-sharing.
- Enhancements to SARB arrangements for liquidity assistance:
  - Introduce a solvency test, preferably in the SARB Act, such that Emergency Liquidity Assistance (ELA) is provided to potentially insolvent financial firms only with an indemnity from the government;
  - Replace remaining collateral prohibitions in the SARB Act with a generic requirement to follow prudent collateral policies;
  - Assess potential liquidity needs of systemic NBFIs, such as CCPs, to determine whether ELA might be needed to preserve systemic functions, with access at the SARB’s discretion and eligibility explicitly defined and made public;
  - Periodically adjust the fee structure of the CLF to ensure banks have adequate incentive to restructure their balance sheets, and revise collateral and haircut policies on some securities classes to reduce potential risks to the SARB.
- Early intervention framework weaknesses:
  - Limitations to the SARB’s authority to suspend licenses, restrict activities, or remove directors or officers of banks.
  - SARB is required in many instances to provide 30 day ex ante notices before taking action against banks or their officers.
  - Reforms needed to align legal framework with good practices and promote early corrective action in troubled banks.
  - Need for a clear statutory basis for Recovery and Resolution Plans (RRPs) and comprehensive guidelines for recovery plans.
  - Explicit powers to the future PA to require changes in group structures and operations would enhance resolvability.
- Resolution regime upgrade to international best practice:
  - Current regime: a curator is appointed by the MoF at or close to insolvency, with powers including taking control of a bank and its assets, seeking temporary relief from creditors, and taking decisions usually subject to a special shareholder resolution.
  - These powers have been used for small bank failures but fall short of the Key Attributes (KA), lacking key features to address systemic cases and minimize taxpayer risk.
  - Recommendation: enhance the resolution regime with all powers in the KAs, including transfer, bridge bank and bail-in powers, and triggers for early deployment when the firm is, or likely to be, no longer viable.
- Judicial or administrative review of resolution actions:
  - A number of provisions in the Banks Act create legal uncertainty or constrain resolution authorities (e.g., a Review Board and the courts can reverse SARB decisions). These should be removed because judicial review should not hinder the exercise of resolution powers, or suspend or reverse regulatory actions.
  - Where authorities are found to have acted in bad faith or gross negligence, relief to claimants should be limited to monetary compensation.
  - Immunity from personal liability provided to SARB officials under the Banks Act should be extended to non-SARB employees appointed to undertake or assist in resolution.
  - Relevant officials should be indemnified for the cost of defending legal actions.
- Deposit insurance and depositor preference:
  - An ex ante-funded DIS, complemented by DP, is desirable.
  - An ex ante fund, with a backup credit line preferably from the NT, can be built up to a prudent target level sufficient for the payout of a number of small and medium sized banks.
  - The fund can be used to support resolution, subject to a strict least cost test.
  - Complementing the fund by introducing DP would increase recoveries for the fund in the event of a payout and facilitate resolution.
  - Absence of DP does not preclude a transfer of retail deposits, but compensation and litigation risks would be higher where retail deposits are treated preferentially in a resolution but rank pari passu with other senior creditors.
  - Note: DP does not provide access to deposit balances as fast as a DIS (e.g., within 7 days), which typically is needed to preserve depositor confidence, and is not a substitute for deposit insurance.

### Promoting Competition in the Financial System
- Long-term objective: authorities should promote more competitive behavior by financial institutions.
- Competition benefits: greater supply of financial services at lower intermediation costs, especially for SMEs and lower income households.
- Existing legal framework limits entry, particularly in the banking sector:
  - Minimum capital requirements (MCR) for banks are between 4 and 100 times higher than in other EMs (Figure 9).
  - Access to clearance and payments is biased against new entrants, contrary to CPSS-IOSCO principle 18.
  - Exits are limited.
- Policy recommendations to promote competition:
  - Lower entry hurdles without sacrificing a stringent fit and proper test for new entrants.
  - Increase information to market participants and ensure transparent entry and exit.
  - Twin Peaks reform provides an opportunity to improve information disclosure and consumer education.
  - Specific measures:
    - Adopt the Basel Committee’s recommendations on point of sale information as quickly as possible.
    - For FMIs, follow CPSS-IOSCO principle 23 on the disclosure of rules, procedures and market data.
    - Remove existing interest rate caps and require financial institutions to be transparent with customers, providing sufficient information to compare products on terms, price, risks and benefits.
    - If not unified, the MCA should have a very close working relationship with the NCR and Competition Commission and operate within a framework of checks and balances.

### Anti Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- Significant progress since the 2008 assessment.
- Strengthening of supervisory framework:
  - Shift to a risk-based approach (RBA) to supervision in the banking sector.
  - Planned expansion of the RBA to AML/CFT measures in the financial sector.
- Supporting actions needed:
  - Amendments to the legal framework;
  - A national risk assessment (NRA);
  - Clearly communicated supervisory expectations;
  - More practical guidance to institutions;
  - An appropriate level of supervisory resources.
- Capacity gaps:
  - Enhanced capacity needed to pursue complex ML cases.
  - Customer due diligence measures need strengthening by requiring financial institutions to identify and verify the identity of beneficial owners.
  - Authorities should have timely access to accurate information on beneficial ownership.
- Priority: Conducting an AML/CFT NRA should be a priority.
  - Reasonable understanding of ML risks is shared by authorities and the private sector.
  - Broad consensus that corruption, fraud and organized crime generate most criminal proceeds in South Africa, and that banks act as the gateway for sub-Saharan funds.
  - Authorities are in the initial stages of preparing the first NRA; its findings should help take appropriate risk mitigating action.

### Box: The Intervention of African Bank
- African Bank Limited (African Bank) was placed under curatorship by the SARB on August 10, 2014.
- Context:
  - Intervention followed record losses that triggered loss of confidence by shareholders and creditors.
  - African Bank was the sixth largest bank in South Africa, accounting for about 1.5 percent of banking system assets.
  - Funded primarily by domestic and externally issued wholesale debt.
  - Main shareholders at time of curatorship: a state-owned investment fund (the Public Investment Corporation) and other institutional investors.
- Resolution and restructuring plan (key elements, noting key figures exactly as presented):
  - A newly established “good bank” comprising retail deposits at face value (of less than 1 percent of total liabilities), senior debt and wholesale deposits written down to 90 percent of their face value, and new capital of approximately ZAR 10 billion, to be underwritten by a consortium of major private banks and the state-owned Public Investment Corporation.
  - Approximately ZAR 26 billion of performing loans from African Bank will be transferred to this “good bank,” which the authorities plan to list in due course.
  - A run-down of remaining impaired assets and liabilities: impaired assets, along with shareholders and subordinated investor claims, will remain in African Bank, under curatorship.
  - SARB announced it will inject ZAR 7 billion (0.2 percent of GDP) to finance the resolution, taking security of impaired loans which were recorded with a book value of ZAR 17 billion, that will not transfer to the “good bank.”
  - Government has not provided any funds to bail out African Bank, but has provided a R7 billion backstop to the SARB in line with international practice.
  - Authorities indicated that it is unlikely that the SARB will draw on this facility, and no costs to the taxpayer are expected.
- Operational and governance recommendations for restructuring:
  - On-going banking entity (“good bank”) needs to be well capitalized and liquid to restore creditor confidence and market access.
  - NT has indemnified the SARB up to R7 billion for the quasi-fiscal risk assumed, but the SARB should conduct careful due diligence of the impaired assets it plans to use as collateral, and revise its valuations if necessary once thorough assessment has taken place.
  - SARB must ensure adequate arrangements are in place so that these loans are efficiently managed and serviced going forward, requiring appointment and proper incentivization of private sector expertise, and that decisions (including with respect to foreclosures) are taken on an arm’s length, commercial basis.

*International Monetary Fund — SOUTH AFRICA (excerpt).*

### Appendix Table 2. SA Bank Subsidiaries in Africa

### Appendix Table 2. SA Bank Subsidiaries in Africa

### SA bank presence in African host markets (market share of host country's banking assets, end 2013)
- Columns: Bank Group — Standard Bank | ABSA Bank | FirstRand Bank | Nedbank | Total | In Percent of Host Country GDP
- Lesotho: 60.3 | 9.7 | 26.9 | 6.9 | 47.0
- Namibia: 25.3 | 29.3 | 12.2 | 66.8 | 41.0
- Swaziland: 29.6 | 18.2 | 16.9 | 64.8 | 29.0
- Angola: 2.4 | 2.4 | 1.0
- Botswana: 12.8 | 14.0 | 19.2 | 45.9 | 30.0
- Congo (DRC): 5.6 | 5.6 | 1.0
- Ghana: 8.0 | 8.2 | 16.2 | 6.0
- Kenya: 5.9 | 7.2 | 13.1 | 10.0
- Malawi: 22.3 | 2.2 | 4.5 | 11.0
- Mauritius: 7.3 | 11.4 | 18.7 | 52.0
- Mozambique: 15.4 | 5.7 | 2.8 | 24.0 | 15.0
- Nigeria: 2.8 | 2.8 | 2.0
- Seychelles: 41.5 | 41.5 | 34.0
- Tanzania: 4.1 | 9.4 | 0.3 | 13.8 | 6.0
- Uganda: 18.0 | 7.6 | 25.6 | 8.0
- Zambia: 13.2 | 11.7 | 3.0 | 28.0 | 11.0
- Zimbabwe: 7.7 | 4.6 | 2.9 | 15.2 | 7.0
- Sources: Bankscope and IMF Staff calculations.

### Market share of largest financial conglomerates (In percent)
- Columns: Financial Conglomerate | Non-Rand area | Rand area | Banking Assets | Assets in Life Insurance | Premiums in General Insurance | Assets Under Manage
- Standard Bank: 25.5 | 11.9 | - | 31.7
- Barclays (ABSA): 20.2 | 0.7 | 2.8 | 21.3
- Old Mutual (Nedbank): 17.2 | 22.4 | 8.6 | 11.3
- FirstRand Bank: 20.4 | - | - | 0.4
- Investec: 7.1 | 4.3 | - | 11.4
- MMI Holdings: n/a | 15.5 | 5.6 | 0.6
- Sanlam Life: n/a | 14.7 | 17.2 | 1.1
- Total share: 90.5 | 69.5 | 34.2 | 77.8
- Sources: Annual Reports, ASISA, and IMF Staff calculations.

### Financial Soundness Indicators (selected; in percent)
- Capital Adequacy
  - Risk-weighted capital adequacy ratio: 2008: 13.0 | 2009: 14.1 | 2010: 14.9 | 2011: 15.0 | 2012: 15.8 | 2013: 15.6 | 2014 Q2: 14.6
  - of which Tier 1 capital: 2008: 10.2 | 2009: 11.0 | 2010: 11.8 | 2011: 12.2 | 2012: 12.6 | 2013: 14.1 | 2014 Q2: 13.5
  - Capital to asset ratio: 2008: 5.7 | 2009: 6.7 | 2010: 7.0 | 2011: 7.2 | 2012: 7.8 | 2013: 7.9 | 2014 Q2: 7.7
- Asset Quality
  - Nonperforming loans (percent of outstanding loans): 2008: 3.9 | 2009: 5.9 | 2010: 5.8 | 2011: 4.7 | 2012: 4.1 | 2013: 3.6 | 2014 Q2: 3.4
  - Nonperforming loans net of provisions (percent of regulatory capital): 2008: 34.4 | 2009: 47.6 | 2010: 40.8 | 2011: 31.0 | 2012: 23.6 | 2013: 19.1 | 2014 Q2: 18.4
- Earnings, Profitability, and Efficiency
  - Return on assets: 2008: 1.5 | 2009: 1.1 | 2010: 1.2 | 2011: 1.5 | 2012: 1.3 | 2013: 1.5 | 2014 Q2: 1.4
  - Return on equity: 2008: 26.9 | 2009: 18.0 | 2010: 18.2 | 2011: 21.0 | 2012: 17.5 | 2013: 18.6 | 2014 Q2: 17.9
  - Interest income (percent of gross income): 2008: 43.6 | 2009: 39.5 | 2010: 43.9 | 2011: 49.1 | 2012: 49.6 | 2013: 48.1 | 2014 Q2: 53.5
  - Trading income (percent of gross income): 2008: 13.4 | 2009: 16.0 | 2010: 13.8 | 2011: 10.5 | 2012: 8.9 | 2013: 7.8 | 2014 Q2: 7.0
  - Non-interest expenses (percent of gross income): 2008: 44.5 | 2009: 48.8 | 2010: 63.4 | 2011: 54.2 | 2012: 53.1 | 2013: 56.3 | 2014 Q2: 57.9
  - Personnel expenses (percent of non-interest expenditure): 2008: 48.3 | 2009: 43.7 | 2010: 43.5 | 2011: 52.6 | 2012: 37.0 | 2013: 47.3 | 2014 Q2: 48.9
- Liquidity
  - Liquid assets (percent of total assets): 2008: 16.8 | 2009: 15.8 | 2010: 16.0 | 2011: 15.7 | 2012: 16.2 | 2013: 16.6 | 2014 Q2: 17.9
  - Liquid assets (percent of short-term liabilties): 2008: 33.2 | 2009: 28.8 | 2010: 32.0 | 2011: 32.6 | 2012: 33.0 | 2013: 33.0 | 2014 Q2: 34.7
  - Customer deposits (percent of total non-interbank loans): 2008: 43.4 | 2009: 46.3 | 2010: 48.0 | 2011: 51.4 | 2012: 52.2 | 2013: 53.1 | 2014 Q2: 53.3
- Exposure to FX risk
  - Effective net open FX position (percent of regulatory capital): 2008: 0.5 | 2009: 0.8 | 2010: -0.3 | 2011: 0.8 | 2012: 0.5 | 2013: 0.3 | 2014 Q2: 0.9
  - Foreign-currency-denominated loans (percent of outstanding loans): 2008: 7.5 | 2009: 7.0 | 2010: 6.7 | 2011: 9.2 | 2012: 8.3 | 2013: 8.7 | 2014 Q2: 9.8
  - Foreign-currency-denominated liabilities (percent of total liabilities): 2008: 5.1 | 2009: 4.3 | 2010: 4.1 | 2011: 4.5 | 2012: 5.7 | 2013: 6.3 | 2014 Q2: 7.2
- Sectoral Distribution of Loans and Advances
  - Residents: 2008: 90.4 | 2009: 91.6 | 2010: 91.2 | 2011: 90.0 | 2012: 90.5 | 2013: 89.2 | 2014 Q2: 88.6
    - Central Bank and Other Financial Corporations /1: 2008: 14.4 | 2009: 12.4 | 2010: 11.3 | 2011: 12.2 | 2012: 12.7 | 2013: 11.2 | 2014 Q2: 12.7
    - General government: 0.6 | 0.7 | 0.9 | 0.9 | 0.8 | 0.7 | 0.6
    - Nonfinancial corporations: 32.7 | 33.6 | 32.4 | 31.3 | 31.0 | 31.1 | 31.8
    - Households: 42.5 | 44.9 | 46.5 | 45.6 | 46.1 | 46.2 | 43.6
  - Nonresidents: 2008: 9.6 | 2009: 9.9 | 2010: 9.5 | 2011: 10.0 | 2012: 9.5 | 2013: 10.8 | 2014 Q2: 11.4
- Derivatives (percent of regulatory capital)
  - Gross asset position in financial derivatives: 2008: 251.5 | 2009: 133.9 | 2010: 124.3 | 2011: 112.5 | 2012: 88.8 | 2013: 70.4 | 2014 Q2: 61.8
  - Gross liability position in financial derivatives: 2008: 249.9 | 2009: 126.5 | 2010: 121.5 | 2011: 112.5 | 2012: 87.8 | 2013: 75.4 | 2014 Q2: 65.1
- Real Estate Market
  - Residential real estate prices (annual percentage change): 2008: -0.4 | 2009: 6.5 | 2010: 0.3 | 2011: 1.7 | 2012: 0.3 | 2013: 8.7 | 2014 Q2: 9.6
  - Residential real estate loans (percent of total loans): 2008: 33.0 | 2009: 34.9 | 2010: 35.3 | 2011: 32.8 | 2012: 30.3 | 2013: 28.5 | 2014 Q2: 27.1
  - Commercial real estate loans (percent of total loans): 2008: 9.0 | 2009: 9.7 | 2010: 9.8 | 2011: 9.5 | 2012: 9.1 | 2013: 8.8 | 2014 Q2: 8.8
- Household Debt
  - Household debt (percent of GDP): 2008: 49.1 | 2009: 47.9 | 2010: 45.0 | 2011: 44.3 | 2012: 45.7 | 2013: 45.1 | 2014 Q2: 45.2
  - Household debt (percent of disposable income): 2008: 82.4 | 2009: 81.5 | 2010: 78.6 | 2011: 78.6 | 2012: 75.4 | 2013: 76.3 | 2014 Q2: 74.5
  - Household debt service (percent of disposable income): 2008: 11.0 | 2009: 10.0 | 2010: 9.0 | 2011: 8.0 | 2012: 7.7 | 2013: 7.7 | 2014 Q2: 7.9
- Source: South African Reserve Bank.
- Note: 1/ Including interbank loans.

### Selected economic indicators (annual percentage change / percent of GDP; projected)
- National income and prices (2010–2015)
  - Real GDP: 2010: 3.1 | 2011: 3.6 | 2012: 2.5 | 2013: 1.9 | 2014: 1.4 | 2015: 2.3
  - Real GDP per capita: 2010: 1.8 | 2011: 2.2 | 2012: 1.1 | 2013: 0.5 | 2014: 0.0 | 2015: 0.9
  - Real domestic demand: 2010: 4.4 | 2011: 5.2 | 2012: 3.9 | 2013: 2.5 | 2014: 1.2 | 2015: 2.0
  - GDP deflator: 2010: 7.7 | 2011: 5.9 | 2012: 4.5 | 2013: 5.8 | 2014: 5.9 | 2015: 5.6
  - CPI (annual average): 2010: 4.3 | 2011: 5.0 | 2012: 5.7 | 2013: 5.8 | 2014: 6.2 | 2015: 5.6
  - CPI (end of period): 2010: 3.5 | 2011: 6.1 | 2012: 5.7 | 2013: 5.4 | 2014: 6.2 | 2015: 5.6
- Labor market
  - Unemployment rate (percent of labor force, annual average): 2010: 24.9 | 2011: 24.8 | 2012: 24.9 | 2013: 24.7 | 2014: 25.2 | 2015: 25.2
  - Average remuneration (formal nonagricultural, nominal): 2010: 13.5 | 2011: 7.2 | 2012: 7.5 | 2013: 7.5 | 2014: 7.0 | 2015: 7.5
- Savings and Investment (percent of GDP)
  - Gross national saving: 2010: 17.1 | 2011: 16.8 | 2012: 14.2 | 2013: 13.5 | 2014: 13.6 | 2015: 13.9
  - Investment (incl. inventories): 2010: 19.1 | 2011: 19.1 | 2012: 19.4 | 2013: 19.4 | 2014: 19.4 | 2015: 19.5
- Fiscal position (percent of GDP)
  - Revenue, including grants: 2010: 27.5 | 2011: 27.9 | 2012: 28.3 | 2013: 28.8 | 2014: 29.1 | 2015: 29.2
  - Expenditure and net lending: 2010: 32.4 | 2011: 31.9 | 2012: 32.6 | 2013: 33.2 | 2014: 33.9 | 2015: 34.0
  - Overall balance: 2010: -4.9 | 2011: -4.0 | 2012: -4.3 | 2013: -4.4 | 2014: -4.8 | 2015: -4.9
  - Primary balance: 2010: -2.3 | 2011: -1.3 | 2012: -1.4 | 2013: -1.3 | 2014: -1.4 | 2015: -1.3
  - Structural balance (percent of potential GDP): 2010: -3.6 | 2011: -3.8 | 2012: -4.2 | 2013: -4.3 | 2014: -4.4 | 2015: -4.5
  - Gross government debt /2: 2010: 35.3 | 2011: 38.8 | 2012: 42.1 | 2013: 45.2 | 2014: 47.6 | 2015: 49.6
- Money and credit
  - Broad money: 2010: 6.9 | 2011: 8.3 | 2012: 5.2 | 2013: 7.2 | 2014: 6.9 | 2015: 7.5
  - Credit to the private sector: 2010: 3.3 | 2011: 5.7 | 2012: 9.3 | 2013: 6.7 | 2014: 7.7 | 2015: 8.0
  - Repo rate (percent) /3: 2010: 5.5 | 2011: 5.5 | 2012: 5.0 | 2013: 5.0 | 2014: 5.8 | 2015: ...
- Balance of payments (percent of GDP unless otherwise indicated)
  - Current account balance (billions of U.S. dollars): 2010: -7.2 | 2011: -9.4 | 2012: -20.0 | 2013: -20.4 | 2014: -19.6 | 2015: -19.9
  - Percent of GDP: 2010: -2.0 | 2011: -2.3 | 2012: -5.2 | 2013: -5.8 | 2014: -5.8 | 2015: -5.7
  - Gross reserves (billions of U.S. dollars): 2010: 43.8 | 2011: 48.9 | 2012: 50.7 | 2013: 49.6 | 2014: 49.6 | 2015: 49.6
  - Total external debt: 2010: 30.5 | 2011: 29.2 | 2012: 37.2 | 2013: 39.1 | 2014: 42.4 | 2015: 44.9
- Sources: South African authorities, World Bank, IMF INS database, and Fund staff estimates and projections.
- Notes: 1/ General government unless otherwise indicated. 2/ Central government. 3/ For 2014, end-August data. 4/ For 2014, end-July data.

### Risk Assessment Matrix — key threats, likelihood, and expected financial stability impacts
- 1. Surge in market volatility and higher-than-expected increases in interest rates
  - Staff assessment (Overall Level of Concern): High
  - Likelihood of Severe Realization of Threat in the Next 1–3 Years: High
  - Expected Impact on Financial Stability if Threat is Realized:
    - Higher rates would affect households’ ability to service debt; deterioration in household debt quality would have a large impact on bank capital.
    - Market volatility could cause significant price changes and spillovers across domestic markets; ST results show banks and insurance companies could sustain large market risk shocks.
    - A sharp fall in capital inflows would likely entail an abrupt reversal of the current account deficit and a concomitant fall in growth, with implications for financial institutions’ asset quality; ST results show that capital ratios of banks remain adequate in the adverse scenarios with lower growth and capital outflows.
    - Banks do not rely heavily on external funding, but large current account and fiscal deficits mean capital inflows affect domestic funding pricing; dependence on short-term wholesale funding and active OTC derivatives trading make large banks susceptible to external shocks and global re-pricing of risk.
    - The flexible exchange rate and limited capital controls may help buffer the economy, but South Africa’s external position remains weaker than implied by desired policies and fundamentals, and reserve coverage remains below most EMs.
- 2. Protracted period of slower growth in advanced and emerging economies
  - Staff assessment (Overall Level of Concern): High
  - Likelihood of Severe Realization of Threat in the Next 1–3 Years: High
  - Expected Impact on Financial Stability if Threat is Realized:
    - External headwinds could trigger a severe recession in South Africa, compounding persistently high unemployment.
    - Substantially lower output and higher unemployment would hamper debt repayment, particularly on unsecured credits.
    - ST indicates the well capitalized banking system would be able to sustain large shocks with manageable recapitalization needs in the most severe scenario.
    - Weaker fundamentals and structural issues would weigh on the sovereign credit rating, potentially increasing funding costs and credit risks of the financial and non-financial sectors.
- 3. Liquidity shortfall in banking system
  - Staff assessment (Overall Level of Concern): Medium
  - Likelihood of Severe Realization of Threat in the Next 1–3 Years: Medium
  - Expected Impact on Financial Stability if Threat is Realized:
    - Banks are dependent on wholesale funding; reliance on short-term deposits (already exceed 60 percent of total deposits) appears to be increasing.
    - Five out of the six banks maintain LCR and NSFR lower than 100 percent. Some banks are yet to meet the minimum 60 percent target (effective 2015).
    - The SARB’s CLF and banks’ strong capitalization should limit run risks and thus the impact.
- 4. Stress in certain financial institutions spilling over to others in the financial system
  - Staff assessment (Overall Level of Concern): Medium
  - Likelihood of Severe Realization of Threat in the Next 1–3 Years: Medium
  - Expected Impact on Financial Stability if Threat is Realized:
    - Financial sector has high interconnectedness; major banks belong to financial conglomerates that own banks and NBFIs or own shares in NBFIs, which provide funding to banks.
    - Lack of a robust group-wide supervisory approach to conglomerate supervision can allow risk accumulation.
    - Large funding provided by NBFIs to banks and concentrated market structures mean idiosyncratic shocks could become systemic.
    - Funding withdrawals by a stressed NBFI are likely to cause significant liquidity shortages in banks; default of a large bank would cause substantial losses to NBFIs.
    - ST shows failure by the five largest financial borrowers of banks causes the CET1 ratio to decline by 1.9 percentage points.
- 5. Losses due to cross-border expansions
  - Staff assessment (Overall Level of Concern): Medium
  - Likelihood of Severe Realization of Threat in the Next 1–3 Years: Medium
  - Expected Impact on Financial Stability if Threat is Realized:
    - Claims of South Africa banks on Sub-Saharan Africa have tripled over the last five years.
    - Incomplete cross-border supervision leaves gaps in risk management.
    - Combined African exposure accounts for only 2 percent of banking assets, but significant presence in neighboring countries means spillovers and spillbacks are possible.
    - Bank supervision and AML/CFT compliance are typically weak in African countries; less developed infrastructure increases cost of doing business.
    - BU STs cover banks’ foreign exposures; overall capital adequacy remains solid under large adverse shocks.

### Banking Sector Stress Testing Matrix — key assumptions and scenarios
- Institutional perimeter
  - Bottom-up by banks: Six banks included; market share: 93.9 percent of total assets in the banking system; bank proprietary data; baseline date: end-Dec 2013; bank solo; foreign and local operations.
  - Top-down by FSAP Team: Four banks included; market share: 85.7 percent of total assets in the banking system; supervisory data and public information; baseline date: end-Dec 2013; bank solo; local operations.
- Channels of risk propagation and methodology
  - Bottom-up: Banks’ internal models; satellite models for credit risk measures, income and expense items, and balance sheet growth; ST horizon: 3-year (2014-2016).
  - Top-down: Guidelines issued by the FSAP team; FSAP team estimated models for credit risk measures; balance sheet approach; ST horizon: 5-year (2014-2018).
- Tail shocks and macro scenarios
  - Baseline scenario: modest GDP growth, persistent high unemployment, gradual upward normalization of interest rates; baseline projections aligned with IMF’s economic projections for South Africa as of April 2014; in August 2014, projections for GDP growth rates in 2014 and 2015 were adjusted to 1.4 and 2.3 percent, respectively.
  - Adverse scenario: mild decline in GDP growth because of a disorderly exit from unconventional monetary policy by advanced economies, resulting in capital outflows, increased market volatility and higher-than-expected increases in interest rates; assumes GDP growth declines to -1.8 percent in the first year, recovering afterwards and turning positive in 2017; the first year shock corresponds to the 2.5 percent left tail of the historical distribution.
  - Severely adverse scenario: a “perfect storm” where GDP falls sharply due to confluence of negative factors (recession in advanced economies; intensified domestic labor tensions amidst high unemployment; large capital outflow; substantially higher domestic interest rates); scenario equivalent to a cumulative eight standard deviation event from baseline; assumes three years of negative growth (-3.9, -3.9 and -1 percent from 2015 to 2017, respectively). The “-3.9” percent growth corresponds to the 0.25 percent left tail of the historical distribution. For BU STs, an additional set of market shocks applies in 2015 in the severely adverse scenario following the US CCAR methodology calibrated to be consistent with those observed in 2008.
  - Macro-financial variables included in scenarios: real GDP growth, repo rate, 10y government bond yield, inflation, unemployment, credit spread between the effective lending rate and prime rate, household debt to GDP ratio, government debt to GDP ratio, domestic credit extension growth, M3 money supply growth, property price growth, stock market index, nominal effective exchange rate, rand/USD effective exchange rate, real GDP growth for key trading partners and regions, oil prices, and commodity prices.
  - Caveat: evolution of macro variables in five-year scenarios is pre-determined and no second round effects are considered.
- Sensitivity analyses (BU STs and TD)
  - Credit risk shocks include failures of five largest non-financial or financial borrowers.
  - Interest rate shocks affecting floating-rate mortgages and unsecured credit.
  - Market risk shocks include upward parallel moves in rates by 200, 300, and 500 bps, downward move by 200 bps; widening/narrowing of Prime-JIBAR spread by 50 and 100 bps.
  - Trading book shocks include widening of credit spreads by 300 and 500 bps for investment grade, 400 and 1000 bps for sub-investment grade, and 500 and 2000 bps for speculative grade.
  - FX shocks: depreciation or appreciation of rand against all currencies by 30 and 50 percent.
  - Commodity shocks: strengthening by 15 and 30 percent and weakening by 15 and 40 percent.
  - Volatility shocks: interest rates volatilities increase by 50 and 100 percent; equity volatilities increase by 50 and 100 percent; rand/U.S. dollar volatilities increase by 20 and 50 percent; commodity price volatilities increase by 50 and 100 percent.
  - Basis risk and counterparty failure scenarios: multiple basis moves and largest counterparty exposures fail (assumed recovery rates specified: largest counterparty recovery rate 55 percent; top non-SA-government issuer recovery rate 40 percent).
- Risks and buffers assessed
  - Credit risk on the banking book and trading book; market risk due to adverse movements in interest rates, exchange rates, equity prices and sustained declines in commodity prices; CVA and incremental default risk considered to assess trading losses.
- Behavioral adjustments applied in scenarios
  - Relative proportions of balance sheet items and trading positions remain the same under macro-financial scenarios.
  - Balance sheet growth depends on banks’ capital adequacy ratios and nominal GDP growth rate, following a rule specified by the FSAP team.
  - Dividend payout depends on banks’ buffer over minimum capital requirements, following a rule specified by the FSAP team.

*Sources: Bankscope; Annual Reports; ASISA; South African Reserve Bank; South African authorities; World Bank; IMF INS database; IMF Staff calculations and estimates.*

### 5. Regulatory

### _cr14340 - 5. Regulatory

### Regulatory and Market-Based Standards and Parameters — Credit Risk / Capital Calibration
- Banks use internal models to estimate PDs, LGDs and RWAs.
- PDs are estimated using satellite models.
- Downturn LGDs are assumed.
- Regulatory RWAs are calculated using the Basel II formula; actual RWAs are assumed to grow at the same rate as the regulatory RWAs.
- Regulatory/Accounting and Market-Based Standards:
  - Capital metrics: Basel III and SA regulatory requirements.
  - Common equity tier one capital.

### Reporting Format for Results — Credit Risk / Solvency Outputs
- Output presentation:
  - System-wide capital ratio and capital shortfall.
  - Number of banks1 in the system that fall below certain ratios.

### Banking Sector: Liquidity Risk (Bottom-up only) — Institutional Perimeter and Data
- Institutions included:
  - Six banks.
- Market share:
  - 93.9 percent of total banking assets in the system.
- Data and baseline date:
  - Bank proprietary data.
  - Positions as of March 31, 2014.

### Banking Sector: Liquidity Risk — Channels, Methodology, and Risks
- Channels of Risk Propagation / Methodology:
  - LCR.
  - NSFR.
- Risks and Buffers:
  - Risks: funding liquidity risk and market liquidity risk.
  - Buffers: SARB’s provision of committed liquidity facility.
- Tail shocks — Size of the shock:
  - LCR: adjustment factors as specified in the Basel Committee on Banking Supervision (BCBS) (2013); which are consistent with stressed funding conditions.
- Regulatory and Market-Based Standards:
  - LCR and NSFR.

### Banking Sector: Solvency Risk — Reporting Format
- Output presentation:
  - The number of banks that fall within certain ratios.
- Footnote:
  - 1/ We prefer not to disclose the distribution by size since it may reveal bank specific information given the small number of banks included in the ST.

### Insurance Sector: Solvency Risk — Institutional Perimeter and Data
- Institutions included:
  - Life: Old Mutual, Sanlam, MMI, Liberty, Discovery.
  - Non-Life: Santam, Mutual&Federal, Hollard, Outsurance.
- Market share:
  - Life: 70 percent (assets).
  - Non-Life: 50 percent (premiums).
- Data and baseline date:
  - Companies’ own data.
  - Reference date: 31/12/2013.
  - Solo-entity basis.

### Insurance Sector: Channels, Valuation, and Horizon
- Channels of Risk Propagation / Methodology:
  - Companies’ internal models.
  - Assumption of no new business during the projection horizon.
- Valuation:
  - Statutory values of assets and liabilities.
  - No discounting of non-life liabilities according to statutory rule.
- Stress test horizon:
  - Instantaneous shocks at reference date, followed by baseline projections for 5 years (2014-2018).
  - Instantaneous shocks in sensitivity analyses.

### Insurance Sector: Tail Shocks, Scenarios, and Sensitivities
- Scenario analysis:
  - Adverse scenario: based on market risk ST semiannually performed by the FSB.
- Sensitivity analysis:
  - Sudden decline in interest rates.
  - Catastrophic event.

### Insurance Sector: Risks, Buffers, and Behavioral Adjustments
- Risks/factors assessed:
  - Interest rates, equity, property, FX, credit spreads, default of largest banking counterparty.
  - Summation of risks within scenarios, no diversification effects.
- Buffers:
  - Absorption effect of technical provisions (profit sharing).
- Behavioral adjustments:
  - Management actions limited to non-discretionary rules in place at the reference date.

### Insurance Sector: Regulatory and Market-Based Standards and Calibration
- Calibration of risk parameters:
  - Interest rates: +50 percent parallel shift.
  - Equity: -50 percent for ordinary shares (-30 percent for fixed-rate preference shares, -10 percent for variable-rate preference shares).
  - Real estate: -30 percent.
  - FX: 30 percent depreciation of ZAR.
  - Corporate spreads: +173bp for investment grade in advanced economies, +321bp for non-investment grade in advanced economies, +217bp for investment grade in emerging economies, +148bp for non-investment grade in emerging economies.
  - Sovereign spreads: +262bp for ZAF.
  - Default of largest banking counterparty: 45 percent LGD on obligations, -100 percent for equity exposures.
- Sensitivity analyses:
  - Interest rates: -35 percent parallel shift.
  - Catastrophe: 1-in100 years probable maximum loss.
- Regulatory/Accounting and Market-Based Standards:
  - Statutory solvency regime (CAR).

### Insurance Sector: Reporting Format for Results
- Output presentation:
  - Impact on solvency ratios (CAR coverage ratios).
  - Capital shortfall for companies falling below 100 percent CAR ratio.
  - Impact on net income.
  - Contribution of individual shocks.
  - Dispersion measures of solvency ratios and net income.

### Country Financial Stability Map (Figure notes)
- Chart axes indicators (legend items shown in figure):
  - Inward spillover risks
  - Credit risks
  - Market and liquidity risks
  - Risk appetite
  - Monetary and financial conditions
  - Macroeconomic risks
- Time points plotted in figure:
  - 2008Q4
  - 2010Q4
  - 2013Q4
- Note: Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite.
- Source: IMF staff calculations.

### Key Findings and Recommendations — Financial Stability Actions, Agencies, Time-frames, and Progress
- Recommendation: Integrate TD stress testing of individual banks in financial stability analysis.
  - Agency in Charge: SARB
  - Time-frame: ST
  - Progress: Full
  - Explanation: The Fund provided technical assistance for TD solvency stress testing to SARB during May 2014, and these STs are now integral to financial stability analysis.
- Recommendation: Remain vigilant on credit risk in banking, stemming from retail and concentrated corporate exposures, and on the funding risks, resulting from reliance on short-term domestic wholesale funding.
  - Agency in Charge: SARB
  - Time-frame: ST
  - Progress: Full
  - Explanation: SARB has established a fully-fledged department to monitor financial stability, which will produce periodic reviews of financial conditions. SARB’s supervisory process monitors emerging risks in banks and for the whole sector. Credit risk exposure is monitored by frontline supervision teams at individual banks, by credit risk analysts for the individual banks and for the sector, and by the research team for the whole sector.
- Recommendation: Focus on market risks in the life insurance companies, and actively engage the long-term insurance companies in a dialogue about their exposures to these risks.
  - Agency in Charge: FSB
  - Time-frame: ST
  - Progress: Full
  - Explanation: All insurers must submit stress testing results on both the market and the insurance risks on an annual basis. Market risk is also assessed as part of the risk assessment done on all insurers. Where market risk is rated as high, the insurer is engaged with as part of on-going supervision.
- Recommendation: Strengthen the off-site stress testing capacity and employ this capacity to inform the regular supervisory discussions.
  - Agency in Charge: SARB, FSB
  - Time-frame: MT
  - Progress: Full
  - Explanation: Banks stress testing is discussed with and the results are reviewed for each individual bank by SARB as part of the Internal Capital Adequacy Assessment Process (ICAAP). The banks stress testing is benchmarked against BIS’s Principles for sound stress testing practices and supervision. All insurers must submit to FSB stress testing results on both the market and the insurance risks on an annual basis.

*Source: _cr14340 - 5. Regulatory*

### Appendix II. 2008 Financial Sector Assessment Program

### Appendix II. 2008 Financial Sector Assessment Program

### Systemic Liquidity, Crisis Management
- Recommendation: Enhance focus on liquidity and funding issues and discuss medium-term strategies to reduce banks’ dependency on wholesale market funding. Analyze in a collaborative exercise between the SARB, the NT, and the FSB, for instance in the context of a Basel II Pillar 2 exercise and in drawing on the results of the planned study of the effects of an eventual lifting of remaining capital controls.
  - Agency in Charge: SARB, FSB, NT
  - Time-frame: ST
  - Progress: On-going
  - Explanation: In 2010 the NT formed a Structural Funding and Liquidity Risk Task Team to review regulatory asymmetries (for example, tax incentives, money market regulations, etc) that may contribute to increasing reliance on short-term wholesale funding. The outcome was increased tax incentives for saving and a broadened investment mandate for pension funds. In addition, SARB developed tools to bolster banks liquidity positions, such as the CLF.
- Recommendation: Continue the strategy to gradually increase foreign exchange reserves and consider establishing standing swap lines with other central banks of the most important settlement currencies—e.g., the Federal Reserve, the ECB, and the Bank of England.
  - Agency in Charge: SARB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The 2 matters are dealt with by SARB’s Standing Committee for Banking and Financial Markets (SCBFM) and is work in progress. Foreign exchange swaps were recently used as the key funding instrument, but the FED was excluded due to its disclosure requirements. Also, as a member of the BRICS, South Africa has access to the Contingency Reserve Arrangement.
- Recommendation: Continue cautious approach to foreign exchange regime liberalization supported by strengthened monitoring and surveillance with: (i) appropriate timing to minimize the risk that the measures would need to be reversed; and (ii) proper reporting by commercial banks, securities dealers, and other market participants to enable the SARB to take corrective actions in a timely manner.
  - Agency in Charge: NT
  - Time-frame: MT
  - Progress: Ongoing
  - Explanation: Generally, South African corporate, institutional investors as well as individuals are allowed to transact in foreign exchange with limited prudential regulation measures aimed at managing South Africa’s offshore exposure. The NT remains committed to reforms, but the timing of reforms have been influenced by exceptional external circumstances such as the prolonged use of unconventional monetary policy in leading economies.
- Recommendation: Review all strategies regarding crisis management as part of the work of the FSCF in light of past crisis episodes experienced globally, and consider undertaking a crisis simulation exercise relating to a macro-financial shock, such as a capital outflow or distress in a large financial sector institution.
  - Agency in Charge: RB, FSB, NT
  - Time-frame: ST
  - Progress: Full
  - Explanation: The FSB-SA is participating in a Resolution Policy Working Group (supported by the World Bank) consisting of the NT, the SARB and the FSB-SA. All FSCF strategies were recently reviewed in a simulation exercise that was conducted by PWC on the 5 March 2014.
- Recommendation: Clarify bank resolution powers by authorizing the registrar of banks, who has extensive powers to safeguard the soundness of the banking system, to directly appoint a curator—limiting the need for the MOF’s intervention only in those cases requiring use of public funds.
  - Agency in Charge: SARB, NT
  - Time-frame: MT
  - Progress: On-going
  - Explanation: A comprehensive Resolution framework consistent with the Key Attributes is in draft stages.

### Foreign Exchange, Capital Markets, and Securities Regulation
- Recommendation: Enhance surveillance of the OTC foreign exchange derivative markets, by systematically pursuing collection and analysis of information on offshore activity.
  - Agency in Charge: SARB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: Since the 2008 FSAP, the Securities Services Act No. 36 of 2004 was replaced by the FMA (No. 19 of 2012) in an effort to align securities regulation in South Africa with international developments including G20, Financial Stability Board, IOSCO and also to effect the recommendations stemming from the FSAP exercise. The specific requirements relating to Trade Repositories (“TRs”) are still being developed.
- Recommendation: Facilitate further development of the stock and bond markets and continue gradual liberalization of exchange controls to attract long-term financing for South Africa’s extensive investment needs.
  - Agency in Charge: NT, SARB, JSE, FSB
  - Time-frame: MT
  - Progress: Ongoing
  - Explanation: With the help of a consultant from the World Bank, the NT together with the SARB and the FSB have engaged with all relevant stakeholders in the South African bond market regarding the need as well as the appropriate approach that should be taken to improve the efficiency of the local bond markets. These deliberations culminated in an agreement to introduce an Electronic Trading Platform for government bonds supported by best practice monitoring and regulation in the South African bond markets.
- Recommendation: Consider consolidation of the responsibility for corporate disclosure of listed securities in the FSB.
  - Agency in Charge: FSB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: As part of the overall regulatory review to introduce a Twin Peaks regulatory framework for the financial markets in South Africa, consideration is being given to among others, the need for a more intrusive regulatory approach. For the time being FSB continuously engages with JSE on this topic.
- Recommendation: Require the ACI to register as a Self-Regulatory Organizations (SRO). The FSB should reexamine whether it should continue to delegate critical responsibilities for the regulation of the unit trust market unless the ACI assumes SRO status and increases its resources and enforcement capacity.
  - Agency in Charge: FSB
  - Time-frame: MT
  - Progress: Full
  - Explanation: The Registrar of Collective Investment Schemes has taken over the regulatory functions from ASISA. The development of the relevant regulation on marketing and advertising is being finalized.
- Recommendation: Assess ability to effectively oversee continued expansion in the OTC market in equity-linked derivatives within the current structure. Consider improved reporting of OTC trading and position concentration by JSE’s member firms, and adoption of margin and concentration rules for member firms trading OTC.
  - Agency in Charge: JSE
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The FMA also enables the provision and development of a regulatory framework for OTC derivatives providers under which providers of OTC derivative products will be licensed/authorized. The regulatory framework is currently being finalized.
- Recommendation: Effect change in settlement cycle on JSE from T+5 to T+3.
  - Agency in Charge: FSB/JSE
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The FSB has made the move towards a T+3 settlement cycle for the equities market a license condition for the JSE and in turn, the JSE has identified the move towards a T+3 settlement cycle as a top priority.
- Recommendation: Increase the size of fines that can be imposed by the JSE, the ACI, and the IRBA to a level that provides a meaningful deterrent commensurate with the significance of the misconduct. FSB’s policy of “name and shame” should be adopted by these other organizations.
  - Agency in Charge: FSB/JSE
  - Time-frame: MT
  - Progress: Full
  - Explanation: The FMA prescribes the maximum amount in respect of fines that can be imposed on issuers and has increased the maximum amount (from R5 million to R7.5 million) that may be levied as was set out in the previous applicable legislation.

### Financial Sector Supervision and Regulation
- Recommendation: Enhance day-to-day collaboration amongst the staff of the different sectoral regulators, in respect of individual institutions and emerging risk issues.
  - Agency in Charge: FSB, SARB, NCR
  - Time-frame: ST
  - Progress: Full
  - Explanation: SARB and FSB have implemented and currently conduct quarterly supervisory colleges for large banking and insurance conglomerates. SARB holds meetings with the NCR as required, but this relationship has been limited by not having a Memorandum of Understanding (MoU). The implementation of the Twin Peaks regulatory will give full legislative force to these changesOn. FSB also holds quarterly meetings with the auditing and accounting bodies.
- Recommendation: Increase focus on qualitative standards, including corporate governance, risk management, and internal controls.
  - Agency in Charge: FSB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The FMA gave the power to FSB to move in this front in most areas, with the notable exception of insurance. A special act is in process.
- Recommendation: Develop the skills of supervisors to meet the growing complexity of the regulatory requirements and the demands of taking a less compliance-based approach to supervision.
  - Agency in Charge: FSB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: Appropriate and on-going training is provided to FSB staff in accordance with an annual training plan, which plan includes training on the risk-based supervisory framework of the FSB-South Africa.
- Recommendation: Further develop risk assessment models, taking a more consistent approach across sectors, and the creation of increased central capacity at the main regulators to identify risk and allocate resources flexibly to issues as they arise.
  - Agency in Charge: FSB, SARB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The FSB has implemented a comprehensive risk-based prudential supervisory approach. This approach promotes early identification and on-going management of systemic and organizational risks enabling the Registrar to focus its supervisory attention on insurers based on the risk profile of the relevant insurer.
- Recommendation: Consider a mechanism for resolving policy disagreements among different regulators and departments and assessing trade-offs among differing policy objectives. The Policy Board for Financial Services and Regulation was created to ensure better coordination, but it plays a purely advisory role to the NT.
  - Agency in Charge: SARB, FSB, NT
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The Twin Peaks reform develops a number of mechanisms to resolve policy disagreements, which will take shape on implementation of the new legislation.
- Recommendation: Consider a more risk-sensitive approach to loans where the borrower has contributed minimum (or zero) equity, including residential mortgage loans with very high loan-to-valuation ratios.
  - Agency in Charge: SARB
  - Time-frame: ST
  - Progress: Full
  - Explanation: The credit risk regulatory return (BA200) has been amended (and implemented as of January 2012) to provide an analysis of loan to value (LTV) ratios of the banks. The breakdown requires banks to report credit exposure for LTVs (>80, 80-100; <100).

### Insurance and Pensions
- Recommendation: Enhance the supervision of groups. The FSB should extend the reporting currently required only of the largest groups to all groups. To maximize effectiveness in this area, the FSB is likely to require additional powers—e.g., to enforce requirements for unregulated holding companies. The FSB could also further develop its approach to lead regulation, maybe in cooperation with the SARB.
  - Agency in Charge: FSB
  - Time-frame: ST
  - Progress: Partial
  - Explanation: Group-wide supervision is currently done on a moral suasion basis. The current approach of the FSB-SA is therefore relatively informal and relies, in respect to information gathering on groups and follow-up action, on the general authority and standing of the regulator rather than specific legislative provisions.
- Recommendation: Develop more guidance on governance, risk management, and internal controls. There are limited requirements in this area at present. Setting out detailed expectations of firms would support continued progress at larger firms and spread good practice to smaller firms.
  - Agency in Charge: FSB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The corporate governance, risk management and internal control measures of insurers is regularly assessed by FSB using off-site monitoring, supplemented with on-site visits, even where there are no supervisory concerns. Where there are supervisory concerns, the Registrar advises insurers accordingly. Most concerns that have arisen have been resolved in a timely manner.
- Recommendation: Consider further enhancements to its life insurance regulation. The FSB should (i) review whether the margin of solvency remains adequate; and (ii) better integrate stress testing into its reporting and supervisory regime.
  - Agency in Charge: FSB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: Monitoring of regulatory capital requirements is strongly embedded in the risk-based supervisory framework. As insurers move closer to the CAR, supervisory action and intervention is intensified and increased, as and when necessary, in accordance with the FSB-SA’s risk-based supervisory framework. All insurers are subject to STs as part of the prescribed annual statutory returns. The major insurance groups are subject to biannual market risk STs.
- Recommendation: Consider improvements in the effectiveness of market conduct supervision by better integrating market conduct issues into its risk assessment model; and increasing coordination internally with the FAIS teams.
  - Agency in Charge: FSB
  - Time-frame: ST
  - Progress: On-going
  - Explanation: JIBAR (which is the key reference rate in the money market and the derivatives market) was revised recently, , a Code of Conduct was finalized by SARB in conjunction with FSB and market participants. The FSB also conducted a gap analysis to monitor compliance with IOSCO principles. The FSB-SA is implementing an approach to market conduct regulation and supervision informed by the concept of TCF. The TCF approach seeks to ensure that fair treatment of customers is embedded within the culture of regulated entities. Despite the fact that the TCF approach has not yet been fully entrenched in the legislative frameworks, the FSB-SA has already begun embedding TCF into its supervisory framework.
- Recommendation: Review NT’s role and responsibilities in relation to those of the FSB in insurance regulation. Best practice in regulation is for governments to define the consumer protection and other objectives of the regulator, give it appropriate powers, and hold it accountable for delivery. In the consumer protection area, the NT could look to the FSB to take a greater leadership role in policy formulation.
  - Agency in Charge: NT, FSB
  - Time-frame: MT
  - Progress: Not implemented
- Recommendation: Consider imposing fit and proper requirements for pension fund trustees, and encourage the development of adequate independent trustee training.
  - Agency in Charge: FSB
  - Time-frame: ST
  - Progress: Full
  - Explanation: The Pension Funds Act has been amended with effect from 28 February 2014, which provides for the registrar to prescribe minimum criteria which trustees must comply with. The registrar is currently in the process of determining the required skills and training needs which will be prescribed soon.
- Recommendation: Consider further measures to encourage consolidation of the pension fund sector, such as strengthening governance and risk management requirements and efforts to stress that trustees must consider issues such as the impact on members balances of high cost structures.
  - Agency in Charge: FSB
  - Time-frame: ST
  - Progress: Not-implemented
  - Explanation: NT is preparing draft regulations.
- Recommendation: Convert the circular on pension fund governance into a regulation, which codifies the duties of trustees, and imposes a range of governance requirements to be enforced by the FSB.
  - Agency in Charge: FSB
  - Time-frame: ST
  - Progress: Not implemented
  - Explanation: Circular PF 130 is currently under review.
- Recommendation: Bring together the different parts of the risk-based model and take into account other factors such as the valuation report provided by defined benefit funds to the FSB Actuarial Division.
  - Agency in Charge: FSB
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The regulator is currently in process of reconsidering the risk-based model to be implemented in the Twin Peaks structure. Currently the funding level of a fund is considered in identifying high-risk funds to be subjected to on-site visits.
- Recommendation: Consider how retirement savings can be released to members in times of hardship—while keeping the key policy objective of preservation of retirement savings until retirement. This would apply to cases where members become unemployed, are threatened with the loss of their home, have to incur substantial medical expenses, or face disability.
  - Agency in Charge: FSB
  - Time-frame: ST
  - Progress: On-going
  - Explanation: Under the current proposals, unemployment, hardship or any of the mentioned incidents will not necessarily be the triggers for accessing preserved retirement savings. Instead, the current proposals recommend that retirement savings be preserved by default when a member changes jobs, but to also enable some limited and unconditional access.
- Recommendation: Ensure that pension reform proposals preserve pension savings until retirement, with appropriate safety valves, and that the drawdown of living annuities is more closely aligned with life expectancy.
  - Agency in Charge: FSB, NT, SARS
  - Time-frame: MT
  - Progress: On-going
  - Explanation: Currently there are preservation proposals issued for public engagement and debate. Default preservation and limited withdrawals when changing jobs is being proposed (see also above). The industry association (Asisa) provides optimal drawdown guidelines. Further, a regulated drawdown for living annuity is currently being proposed if such an annuity is provided as a default product.
- Recommendation: Ensure that provident funds move away from providing only lumps sums towards a requirement that they must provide a form of lifetime income.
  - Agency in Charge: FSB, NT
  - Time-frame: MT
  - Progress: Full
  - Explanation: Requirement for provident fund members to annuitize a portion of their benefit is already enacted in the Taxation Laws Amendment Act No. 31 of 2013 and will become effective 1 March 2015. The requirement will only apply to new contributions from that date onwards by members who are younger than 55 years on the implementation date and if those new contributions exceed R150 000 and for those who are younger than 55 on 1 March 2015.

### Financial Sector Inclusion, Consumer Protection and Housing Finance
- Recommendation: Continue to support efforts to preserve the FSC and enhance its inclusion targets by setting targets that prioritize higher-quality transaction and deposit products, establishing new access targets for using the delivery of social grants and other products to bring unbanked individuals into the formal system, giving attention to bringing down costs and increasing availability, and focusing on improved insurance products with emphasis on simple, flexible long-term products.
  - Agency in Charge: NT, DTI
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The Financial Sector Charter has been finalized and the agreement has been gazetted (Q1, 2012), with targets and product standards (for banking and insurance) aimed at increased financial inclusion and impact. The monitoring and reporting process through the Financial Sector Council, involving the industry representative bodies, is in place and will continue until 2018.
- Recommendation: Review the mandates, products, and governance of DFIs to maximize their catalytic role.
  - Agency in Charge: NT, DTI
  - Time-frame: MT
  - Progress: FuFull
  - Explanation: Completed in 2009.
- Recommendation: Clarify reckless lending provisions and debt counseling mechanisms under the NCA. This involves specifying to whom the provisions apply, how lenders comply with them, and how borrowers are informed of their rights and responsibilities.
  - Agency in Charge: NCR
  - Time-frame: ST
  - Progress: On-going
  - Explanation: Provisions in the National Credit Amendment Bill (awaiting assent by the President) allow for the definition of affordability criteria (in effect the definition of reckless credit) and fit and proper standards for debt counselors.
- Recommendation: Use the National Debt Mediators Association code and procedures which are being developed for dealing with the bulk of the cases of over-indebtedness and mandate lenders to participate.
  - Agency in Charge: NCR
  - Time-frame: MT
  - Progress: Not implemented
  - Explanation: Approval of the Code of Conduct of Credit Providers to Combat Over-indebtedness (encompassing National Debt Mediators Association initiatives) has been withdrawn by the NCR.
- Recommendation: Analyze the NCR link to the DTI and determine options for alternative institutional placement. This could include placing the NCR under the remit of the NT.
  - Agency in Charge: NCR, NT
  - Time-frame: MT
  - Progress: Full
  - Explanation: This has been contemplated in Twin Peaks reform and will come into force upon implementation of the new legislation.
- Recommendation: Introduce a consumer-friendly gateway to the various ombuds schemes.
  - Agency in Charge: NCR, NT
  - Time-frame: MT
  - Progress: Partial
  - Explanation: A single entry call centre number has been implemented. Further measures are contemplated under Twin Peaks (Financial Sector Regulation Bill).
- Recommendation: Review the resources, staffing, and institutional arrangements of the NCR to ensure they are adequate and appropriate.
  - Agency in Charge: NCR
  - Time-frame: ST
  - Progress: Full
  - Explanation: This has been contemplated in Twin Peaks reform and will come into force upon implementation of the new legislation.
- Recommendation: Improve access to free credit reports.
  - Agency in Charge: NCR
  - Time-frame: ST
  - Progress: Implemented
  - Explanation: Consumers may obtain a current credit report free from all credit bureaus annually.
- Recommendation: Develop a regulatory framework for CPI-indexed mortgage loans that index both debt and repayments and which could be funded by CPI-indexed bonds.
  - Agency in Charge: NT, Housing
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The financial crisis largely caused by mortgage loan incentives has resulted in some re-examination in this area.
- Recommendation: Consolidate and track data on overall housing finance debt and related performance including by income level and beyond the sole mortgage loans held by commercial banks.
  - Agency in Charge: SARB, FSB, NCR
  - Time-frame: MT
  - Progress: On-going
  - Explanation: SARB analyses mortgage credit exposure of the banking sector as part of the information received for supervision purposes.
- Recommendation: Conduct an in-depth analysis of market needs among affordable housing lenders to (i) adjust the mandate, products, and organization of the housing finance DFIs (the priority being to restructure NHFC); (ii) study the feasibility of a simple credit risk-sharing tool for FSC lenders (still limiting government contingencies); and (iii) adjust the program of credit linked subsidies.
  - Agency in Charge: NT, Housing
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The development of a financing mechanism to accompany the rationalization of DFIs is currently underway and is being led by the Department of Human Settlements. The proposal to develop public mortgage default insurance was received in light of concerns relating to risk sharing and future capitalization needs. The credit linked subsidy program has been adjusted at two levels since 2012. Further reforms to the subsidy program relates to the purchase of an existing house, to support the creation of a secondary market.
- Recommendation: Harmonize the regulations applied to mortgage loans between the NCA and the Home Loan and Mortgage Disclosure Act.
  - Agency in Charge: NCR, Housing
  - Time-frame: MT
  - Progress: Not-implemented
  - Explanation: The extensive reporting in the NCA renders the HLAMDA unnecessary.
- Recommendation: Revisit land and housing policy tools to allow an expansion of housing supply and reduce the growing affordability gap.
  - Agency in Charge: Housing, NT
  - Time-frame: MT
  - Progress: On-going
  - Explanation: The creation of the Urban Settlements Development Grant provided for a new mechanism to support bulk infrastructure and serviced land for low income housing. The Spatial Planning and Land Use Management Act promulgated in 2013 streamlines the fragmented development planning framework.

*Source: Appendix II. 2008 Financial Sector Assessment Program*

### Annex I. Report on the Observance of Standards and Codes

### Annex I. Report on the Observance of Standards and Codes — BASEL CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION

### A. Introduction
- Assessment completed as part of a Financial Sector Assessment Program update undertaken by the IMF during 2014.
- Reflects the regulatory and supervisory framework in place as of the date of completion of the assessment.
- Not intended to represent an analysis of the state of the banking sector or crisis management framework (these were addressed in the broader FSAP exercise).

### B. Background Information and Methodology
- Assessment focused on banking supervision and regulation in South Africa; did not cover supervision of other financial intermediaries (covered by other FSAP assessments).
- South Africa agreed to be assessed according to the Revised Core Principles Methodology issued by the BCBS in September 2012.
  - This assessment used the revised content and methodology (significantly different from the 2010 assessment).
  - The revised BCPs have a heightened focus on risk management and supervisory assessment practices.
- Authorities chose to be assessed against both the Essential and Additional Criteria but were rated only against the Essential Criteria.
  - Compliance judgments made on a qualitative basis using Essential Criteria to gauge full compliance with a CP.
  - Additional Criteria were assessed as recommended best practices but not rated.
- Assessors reviewed laws, rules, and supervisory materials; held extensive meetings with BSD of the SARB, NT, auditing firms, and banking sector participants.
- Authorities provided a self-assessment, responses to questionnaires, and access to supervisory documents, files, staff, and systems.
- Proportionality: evaluation considered the complexity, interconnectedness, size, risk profile and cross-border operations of banks supervised; assessments are context-specific and not directly comparable across jurisdictions.

### C. Institutional and Market Structure—Overview
- Responsibility for bank regulation and supervision: South African Reserve Bank (SARB), exercised through the Registrar of Banks and the Bank Supervision Department (BSD) under the Banks Act of 1990 (BA).
  - Some powers formally rest with the MoF (e.g., issuing regulations and formalizing important supervisory actions).
  - BSD also responsible for mutual banks under the Mutual Banks Act of 1993.
  - National Credit Regulator (NCR) reports to the Minister of Trade & Industry and has regulatory power over lending activity for consumer protection.
  - Financial Intelligence Center (FIC) acts as the country’s Financial Intelligence Unit (FIU).
- Adoption of international standards and Basel implementation:
  - Implementation of Basel III started since 2013.
  - BSD attaches strong importance to BCBS standards and other international bodies (FSB, IASB).
  - South Africa was one of the first jurisdictions implementing Basel II and 2.5.
  - A shorter phase-in period for Basel III capital than internationally agreed is set.
  - An additional capital requirement of 1 percent is required for all banks.
  - Authorities intend to introduce the LCR and the NSFR according to the internationally-agreed timeframe.
- Financial Sector regulatory architecture and planned reform:
  - Financial Services Board (FSB) has broad regulatory authority over insurance and certain securities activities; supervisory responsibilities for market intermediaries are split between FSB and the JSE.
  - Twin Peaks restructuring planned: creation of a Prudential Authority (PA) located in the SARB and a Market Conduct Authority (MCA) situated in the FSB.
  - NT published a relevant bill for public consultation (expected to be revised further); amendments to acts such as the Banks Act expected following reorganization.
- Size and structure of the financial sector:
  - Total financial sector assets about 298 percent of GDP.
  - Commercial banks assets slightly more than 112 percent of GDP.
  - Banks’ share of total financial assets has declined and currently comprises less than 40 percent of the total.
  - Close to 95 percent of banking assets is domestic.
- Banking sector composition and concentration:
  - Banking sector comprised of 31 banks and foreign bank branches.
  - Highly concentrated: five large banks—ABSA Bank, FirstRand Bank, Nedbank, Standard Bank of South Africa, and Investec Bank—together account for more than 90 percent of total banking assets.
  - Sector also includes 7 locally owned banks, 5 subsidiaries of foreign banks, and 14 branches of foreign banks (end-2013).
  - Four of the five large banks provide full-scale nationwide services; Investec focuses on corporate and private banking.
- Cross-border and cross-sectoral linkages:
  - Ownership and group structures link major banks with U.K. groups and insurance companies (examples include Barclays/Barclays Africa Group, Nedbank/Old Mutual, Standard Bank/Liberty Group, Investec dual-listing).
  - Four of the top five banks have 39 subsidiaries in 17 sub-Saharan countries.
- Banking soundness indicators and risk features:
  - Non-performing loans (NPLs) rose from 2 percent of total loans at the onset of the crisis to 6 percent in late 2009, then declined to 3.6 percent in 2013.
  - Regulatory tier one ratio of 13.4 percent in 2013.
  - ROE of the four largest banks staying close to 20 percent.
  - SARB applies a 1 percent systemic risk surcharge to the large banks in addition to MCR.
- Funding profile and liquidity features:
  - Short-term deposits (6 months in maturity) rose to 63.3 percent of total deposits from 60.3 percent in 2008.
  - Liquid asset to short-term liabilities ratio around 16 percent.
  - Deposits constitute 87.5 percent of bank funding; about 60 percent of deposits represent wholesale funding from non-bank financial institutions and corporations with maturities of six months or less.
  - Average loan-to-deposit ratio is 127 percent.

### D. Preconditions for Effective Banking Supervision
- SARB mandate and financial stability role:
  - SARB’s mandate to promote financial stability was added by the MoF in 2010.
  - SARB established the Financial Stability Committee and separated the Financial Stability Department from BSD.
  - SARB’s macroprudential tasks include assessing system-wide risks; sharing risk assessments; contributing to macroprudential instrument development; and implementing discretionary policy actions.
  - SARB publishes Financial Stability Review twice a year.
- Systemic oversight and crisis coordination under Twin Peaks:
  - FSOC (chaired by SARB Governor) will include PA and MCA as members and NT representative as observer; FSOC to monitor and assess systemic risks, make recommendations, and play a central role in crisis management and resolution.
- Bank resolution framework and planned reforms:
  - Current regime: curator appointed by the Minister (on Registrar’s recommendation) when a bank is close to insolvency; curator has broad powers but regime lacks critical features for systemic cases and minimizing risks to public funds.
  - No mandatory recovery plans required by law; BSD announced phased introduction of recovery and resolution planning through Guidance Notes.
  - Authorities committed to reforming the resolution regime to be compliant with the Key Attributes of Effective Resolution by end 2015 (as a member of the FSB).
- Systemic protection and liquidity backstops:
  - No depositor protection scheme (DIS) or formal framework for systemic liquidity provision; authorities have intervened ad hoc in past failures (capital and liquidity injections mostly by SARB).
  - SARB established a Committed Liquidity Facility (CLF) to support banks meeting the Basel III LCR requirement from 2015; CLF does not preclude the SARB from providing ELA on different terms.
  - FSCF (chaired by a Deputy Governor of SARB) includes representatives from NT, SARB, and FSB and coordinates contingency planning for financial crises.
- Legal, accounting, audit, and financial infrastructure:
  - South Africa has a well-developed system of laws: Companies Act (CA) updated; includes bankruptcy/insolvency provisions; King Report III applicable to JSE-listed companies; Consumer Protection Act and National Credit Act (NCA) in place.
  - Accounting and auditing:
    - International Financial Reporting Standards (IFRS) and International Standards on Auditing (ISA) implemented since 2005.
    - JSE requires listed companies to use IFRS since January 1, 2005.
    - Companies Act Regulations permit IFRS, IFRS for SMEs, or South African GAAP in specific instances.
    - Financial Reporting Standards Council formed in 2011 to advise the Minister of Trade and Industry on financial reporting standards.
    - Independent Regulatory Board for Auditors (IRBA) oversees registered auditors.
    - South African Institute of Chartered Accountants (SAICA) has more than 36,000 members.
    - Auditing and Assurance Standards Board (including SAICA) ensures consistency with IAASB pronouncements.
  - Financial market infrastructure:
    - JSE: primary exchange and largest in Africa; SAFCOM is a JSE wholly owned clearinghouse for derivatives.
    - Strate: the central securities depository (CSD) for electronic settlement of securities for JSE and other markets; acts as clearinghouse for some debt trading.
    - SAMOS: SARB-owned real-time gross settlement national payment system that settles rand settlement of financial market transactions, interbank transactions and foreign exchange transactions with other international banks.
    - Four major credit bureaus provide consumer and business credit information; NCA requires Minister of Trade & Industry to publish regulations on credit bureau data handling; NCR provides oversight over credit bureaus.
    - Credit bureau data contributors include banks, credit-driven retailers, credit card companies, micro lenders, telecommunication and insurance companies, courts, debt counsellors, debt collectors.

*Report prepared by Elizabeth Roberts (external expert) and Mamoru Yanase (IMF); assessment reflects the framework and information provided to the assessment team.*

### 25.      South Africa has a high level of compliance with the BCPs. The current supervisory

### 25.      South Africa has a high level of compliance with the BCPs.

### Key findings
- South Africa has a high level of compliance with the BCPs.  
- The current supervisory regime is based on strong relationships with bank Boards and senior management, as well as with banks’ internal and external auditors, supported by intensive qualitative and quantitative analysis.  
- The Registrar of Banks (the head of banking supervision) and his staff in the BSD hold banks to a very high standard of corporate governance and risk management.  
- The South African banking system is highly concentrated with more than 90 percent of banking assets being controlled by the five largest banks.  
- The same laws, regulations and supervisory processes apply to all banking institutions, irrespective of their size; however, under a risk-based system, supervisory focus and resources naturally center on the largest institutions.

### Commitment to international standards and supervisory developments
- The SARB, as a member of the BCBS, is committed to adoption of international standards and sound practices promulgated by the BCBS, as well as other relevant international standard-setting bodies.  
- The SARB has implemented, or is in the process of implementing, all of the BCBS standards, most notably those related to capital adequacy and liquidity.  
- SARB is commended for encouraging and supporting its supervisory counterparts in neighboring countries in implementing key standards, which should help ensure adequate oversight of South African banks’ cross-border operations as they expand.

### Institutional strengthening and recent improvements
- Since the previous assessment conducted in 2010, the BSD has made several significant improvements:
  - Increased supervisory staff by almost 50 percent.
  - Added a corps of risk specialists to complement analysis teams.
  - Added additional on-site inspectors, enabling more direct interaction with banks and less reliance on external auditors.
  - Addressed several shortcomings in bank regulations since 2010.
  - Strengthened cooperation with relevant domestic and foreign supervisors.

### Areas warranting improvement (legal/regulatory/powers)
- Remaining weaknesses in legal and regulatory frameworks and supervisory powers include:
  - Legal provisions related to objectives of the supervisory institution and appointment and dismissal of its head.
  - Power to suspend or limit a bank’s registration expeditiously.
  - Supervisory techniques to address risks stemming from the non-banking activities of a financial group.
- While BSD has largely worked around these weaknesses, amendments to appropriate laws and regulations should be made as soon as possible. The SARB anticipates further strengthening of laws and regulations in the next round of amendments expected as part of restructuring the financial regulatory system.

### Twin Peaks transition: opportunities and cautions
- The NT announced its intention to adopt the Twin Peaks model of financial regulation in 2011.
- The new Prudential Authority (PA) will be a department within the SARB; current BSD staff will become part of the new Authority, merging with prudential supervisors of insurers and other financial institutions currently within the FSB.
- This move has potential to safeguard banking system stability given banking groups’ substantial involvement in insurance and other financial activities.
- The new prudential supervisor needs to:
  - Establish an appropriate framework and improve tools to supervise diversified entities without undermining current high quality oversight of banks.
  - Review supervisory approach after organizational changes to enable capacity to monitor prudential risk of the entire financial system and financial conglomerates.
  - Add tools such as common scenario stress testing across different financial sectors and a risk rating framework that takes into account the entire risk of financial groups.
  - Cooperate closely with the planned FSOC and its secretariat.

### Summary of Compliance with the BCP — Selected Core Principle observations and recommendations
- Responsibilities, objectives, and powers
  - The Banks Act (BA) and associated rules provide a broadly appropriate framework and clear responsibilities and adequate powers to the Registrar of Banks and the BSD.
  - Lack of legally defined objectives of the supervisor and regulation and supervision of banks is a shortcoming of the current BA; authorities plan to address this in the expected Twin Peaks reform.
  - Recommend review: extent of delegation of powers in the Banks Act (transfer granular requirements from tier 2 rules to tier 3 rules) and composition of the Standing Committee for the Revision of the Banks Act to insulate process from direct industry interests.

- Independence, accountability, resourcing and legal protection for supervisors
  - BSD has an appropriate level of resources with highly qualified staff and substantial specialist skills recently added, though some need more experience.
  - Legal protection of the supervisor is adequate; operational independence is fully respected in practice but needs to be enshrined in legislation to be fully compliant with the CP.
  - Recommend revising appointment/removal process of the Registrar to include (A) a fixed term of the appointment, (B) specific reasons for the removal, and (C) the requirement to publish the reasons for removal, as required in EC2.
  - Recommend limiting Minister’s involvement to cases absolutely necessary and clarifying objectives for intervention in law.
  - Authorities should review adequacy of resources reflecting expected changes under Twin Peaks and need for improvements in supervisory approach as recommended in CP 8, 9, and 12.

- Cooperation and collaboration
  - Legal provisions and operational frameworks for cooperation with domestic and foreign authorities are in place.
  - Regarding confidentiality of information, reliance on SARBA Section 33 and the manner BA Section 89 is stipulated leave room for information to be used for non-supervisory purposes.
  - Recommend review of BA provisions to ensure confidential information shall only be used for supervisory purposes, unless specifically required by court orders or provisions in other laws.

- Permissible activities
  - The Banks Act provides clear definitions of activities only permitted to be conducted by registered banks, including taking deposits from the public.

- Licensing criteria
  - Laws and regulations related to licensing and BSD’s process provide a comprehensive framework to assess adequacy of new registrations, including foreign bank branches; BSD adequately assesses applications in practice.

- Transfer of significant ownership
  - Laws, regulations and supervisory practices provide adequate control and oversight regarding significant ownership of a bank and a controlling company.

- Major acquisitions
  - Major acquisitions and investments by banks and controlling companies are subject to prior approval by the Registrar; BSD has well established practices to limit and monitor risks from such activities.

- Supervisory approach
  - SREP cycle and risk rating system provide an adequate general framework; supplemented by sector-wide approaches and thematic on-site reviews.
  - Resolution approaches are still in development: recovery plans and contingency planning have started, but resolution plans for systemic banks have yet to begin.
  - Assessors urge enactment of the bank resolution bill expeditiously to grant required powers.
  - Transition to Twin Peaks should include improved oversight over systemic risk and wider financial groups; may require more formalized framework to detect and assess system-wide and cross-sectoral risks.

- Supervisory techniques and tools
  - BSD has moved from substantial reliance on external auditors to conducting its own on-site reviews, including deep-dive reviews and extensive review of loan files.
  - Added risk specialists conduct on-site reviews on particular risk areas including model validations.
  - Assessors encourage continued enhancement of ability to conduct deep-dive on-site reviews and improvement of tools and techniques to assess and monitor spill over risks from non-banking activities in financial groups.

- Supervisory reporting
  - Regulatory framework requires banks and controlling companies to periodically submit a broad range of information.
  - Strong regulatory and supervisory processes ensure accuracy and comparability of submitted returns; well developed procedures exist for analysis and feeding into supervisory actions.

- Corrective and sanctioning powers of supervisors
  - Major problem remains: need for 30 days prior notice in suspending registration or restricting activities based on BA Sections 23, 24, and 26 has not been changed.
  - Newly introduced power of directives under BA Section 6(6) and application of a motion by the court could partially address the issue, but limitations and uncertainties remain.
  - Assessors view that strengthening laws to provide the Registrar with the power to suspend or limit a bank’s activities without delay is essential.
  - Lack of ability for the supervisor to fine individuals related to banks, such as Board members and senior management, is another important gap.

- Consolidated supervision
  - Supervisory and reporting framework provides an adequate framework for monitoring risks from non-banking and foreign banking operations.
  - Given prevalence of conglomerate-type financial groups, authorities should further monitor and manage risks arising from non-banking activities or parent entities (some not bank controlling companies).
  - Recommend strengthening techniques such as group-wide stress testing and improving recovery and resolution planning of large banking groups once necessary powers are available.

- Home-host relationships
  - Current arrangements for cooperation with foreign supervisors are broadly adequate but cooperation with supervisors in other African countries needs further enhancement as South African banks expand.
  - Encourage continued support for capacity building of these supervisors and finalization of policies and processes for on-site reviews of South African banks’ cross-border operations in other African countries.
  - Enhance cross-border recovery and resolution planning, including close collaboration with UK authorities for banks with strong UK ties, and due regard to impacts on host jurisdictions where foreign operations have become systemically important.

- Corporate governance
  - Through regulations and practice, the SARB places strong emphasis on sound and effective corporate governance at all banks.
  - BSD staff can assess corporate governance via meetings, audit reports, and Board/Board committee minutes review.

- Risk management process
  - SARB’s SREP cycle emphasizes verification that banks have robust risk management policies and procedures.
  - Recent increase in supervisory staff has allowed formation of specialized teams to review major risk categories; some newer members are strengthening skills through on-the-job experience.

- Capital adequacy
  - SARB has adopted or is in the process of adopting components of Basel II, 2.5 and III according to or in advance of the Basel Committee schedule.
  - Capital is calculated on a consolidated and solo basis for all banks; BSD can impose additional capital requirements on individual banks as necessary.
  - BSD has applied the three Basel ratios (CET1, tier 1 and total capital) as well as systemic capital requirements, large bank capital add-ons and a “Board buffer”.
  - BSD staff regularly assesses banks’ capital management and planning, most intensely at the largest internal ratings based banks.

*IMF Staff Assessment (excerpt).*

### 17.   Credit risk Regulation 39 clearly sets out the requirement for adequate policies and

### _cr14340 - 17.   Credit risk Regulation 39 clearly sets out the requirement for adequate policies and

### Credit risk governance and supervision
- Regulation 39 requires adequate policies and procedures related to credit risk management, approved by the Board of directors and effectively implemented by management.
- BSD staff, including the analyst(s), credit specialist team and on-site review team, take an active role in assessing the quality of credit risk management at all banks, including as part of the SREP.

### Problem assets, provisions, and reserves
- BSD monitors problem assets at individual banks through regular reports, review of external auditor reports and selected on-site examinations.
- Supervisory staff evaluates adequacy of banks’ provisioning for problem assets on both an individual bank and peer group basis.
- Assessors encourage BSD to finalize as soon as possible the draft Directive on restructured credit exposures to help prevent banks from using restructuring to improve classified loan levels.

### Concentration risk and large exposures
- Regulations require the Board and senior management to establish and maintain adequate policies and procedures related to concentration risk and large exposures.
- BSD utilizes quarterly reports from banks to monitor large exposures and risk concentrations.
- BSD also monitors Board and management oversight of concentration risk through SREP and ICAAP reviews.

### Transactions with related parties
- Regulations provide a comprehensive definition of “related person” and require arm’s-length transactions between banks/controlling companies and related parties.
- Regulation 39 requires Board and senior management to ensure monitoring and reporting of individual and aggregate exposures to related persons are subject to an independent individual credit review process.
- BSD receives and reviews information on transactions with related parties on a quarterly basis; matters of concern are discussed in prudential meetings with individual banks.
- Assessors recommend that SARB amend regulations so the Registrar can set limits on exposures to any related parties; currently the Registrar can only set limits on intragroup transactions and exposures.

### Country and transfer risks
- Regulation 39 was amended to specifically include country and transfer risks.
- The BA 210 quarterly report was amended in 2011 to require more granular information on banks’ country and transfer risks.
- BSD monitors such exposures on an ongoing basis through SREP and includes this risk category in discussions with Boards, management and auditors.
- While the level of country and transfer risk for most banks remains relatively small, monitoring is ongoing.

### Market risk
- SARB has implemented a comprehensive approach to supervision of market risk, especially at the largest banks approved for the INTERNAL MODELS APPROACH.
- For most banks in South Africa, market risk remains at rather modest levels.

### Interest rate risk in the banking book (IRRBB)
- Banks currently face minimal IRRBB because a large percentage of lending is done on a floating rate basis.
- BSD reviews banks’ policies and procedures to manage IRRBB as part of SREP.
- BSD is giving IRRBB more focus in 2014 and providing additional training to analysis teams.
- Assessors encourage BSD to continue plans to further strengthen review of banks’ internal interest rate risk measurement systems.

### Liquidity risk
- BSD has initiated adoption of the LCR by South African banks and intends to implement the NSFR on schedule.
- Implementation faces constraints due to limited supply of government bonds, an illiquid and small corporate debt market, and disintermediation of retail funding through MMFs into the banking sector.

### Operational risk
- SARB has developed a robust program combining on-site and off-site analysis to assess operational risk management quality at individual banks.
- BSD has enhanced the specialist operational risk team, which includes IT experts.

### Internal control and audit
- BSD closely monitors adequacy of internal controls and compliance at individual banks through off-site practices, review of internal reports, and meetings with Board audit committees, internal auditors and compliance officers.

### Financial reporting, disclosure and transparency
- Banks are required to publish financial statements based on IFRS and have them audited; supervision leverages a strong working relationship between BSD and external auditors.
- Banks are required to disclose a wide range of information to the public on a regular basis.
- Pillar 3 disclosures are not currently audited (as permitted under the Basel capital framework) and are reviewed only sporadically by BSD staff.
- With recent staff increases, BSD should assign responsibility for reviewing Pillar 3 disclosures to analysts or other suitably skilled staff, or require external auditors to review them.

### Abuse of financial services / AML-CFT
- The BA, associated regulations and the revised Financial Intelligence Centre Act (Act No. 38 of 2001) provide a generally adequate framework for supervising banks’ policies and processes against abuse of financial services.
- BSD has stepped up AML/CFT supervision: a dedicated unit was established, on-site inspections of large banks completed, administrative fines recently imposed on some large banks, and increased attention within SREP.
- Weaknesses remain: FIC Guidance Notes (including the risk-based approach) lack legal enforceability under FICA; enforceability via BA-based supervisory powers has not been formally tested.
- On-site inspections of all banks are not yet completed.

### Key statistics and market structure (insurance sector context)
- In 2013, assets held by insurers accounted for nearly 23 percent of financial sector assets in South Africa.
- As at end-2013, there were 78 long-term insurers, 87 short-term insurers, 6 reinsurers and 11 captive insurers (excluding cell captive insurers).
- The long-term insurance sector is highly concentrated with the top five conglomerates dominating the market with over 73 percent of total industry assets in 2013.
- Approximately 10,992 FSPs as at March 31, 2014.
- Stress testing (ST) by FSB-SA found only two small insurers demonstrated inability to remain solvent under an adverse market risks scenario.
- FSB-SA’s combined ST scenario revealed a few short-term insurers might be under solvency strains; this is still being investigated.

### Systemic and group-level risks
- Considerable inter-linkages and cross-ownership exist; some large conglomerates involve domestic banks indirectly owning insurers.
- Long-term insurers are a major source of funding for banks; shocks in one sector can be transmitted across the financial system.
- Insurers face challenges in diversified cash management due to a concentrated banking system, particularly for short-term insurers with significant share of deposits and MMFs in the banking system.
- Move to a Twin Peaks supervisory structure aims to enhance conglomerate-level supervision and improve CoB supervision.

### Recommendations to improve compliance with the BCPs (selected, by Core Principle numbers)
- 1. Responsibilities, objectives and powers
  - Define objectives of the supervisor in the legal framework.
  - Review delegation of powers in the Banks Act to transfer granular requirements from tier 2 rules (regulations) to tier 3 rules (circulars, directives).
  - Review composition of the Standing Committee for the Revision of the Banks Act to insulate the process from direct industry interests; include retired industry officials or academics as experts.
- 2. Independence, accountability, resourcing and legal protection for supervisors
  - Revise legal framework for the head of the supervisor to include (A) a fixed term of the appointment, (B) specific reasons for removal, and (C) the requirement to publish reasons for removal.
  - Limit Minister’s involvement to absolutely necessary cases and clarify objectives for intervention.
  - Review adequacy of resources reflecting expected changes under Twin Peaks.
- 3. Cooperation and collaboration
  - Ensure confidential information is used only for supervisory purposes unless required by court orders or other laws.
- 8. Supervisory approach
  - Enact legislation to provide supervisor power related to resolution of banks expeditiously and develop resolution plans.
  - Review supervisory approach after organizational changes to equip it to monitor prudential risk of entire financial system and financial conglomerates.
- 9. Supervisory techniques and tools
  - Enhance supervisor’s ability to conduct deep-dive on-site reviews.
  - Improve tools and techniques to assess and monitor spillover risks from non-banking activities in financial groups.
- 11. Corrective and sanctioning powers of supervisors
  - Strengthen laws to provide power to suspend or limit a bank’s activities without delay.
  - Provide power to fine individuals related to banks.
- 12. Consolidated supervision
  - Strengthen group-wide supervisory techniques, such as stress testing, to monitor risks from non-banking activities or parent entities.
  - Improve recovery and resolution planning of large banking groups, including scenarios where shocks originate from non-banking entities or parent groups.
- 13. Home-host relationships
  - Support capacity building of host supervisors of African operations of South African banking groups.
  - Finalize policies and practices to conduct on-site reviews of cross-border operations in other African countries.
  - Enhance cross-border recovery and resolution planning with close collaboration with UK authorities and supervisors in jurisdictions where South African banks have significant operations.
- 18. Problem assets, provisions, and reserves
  - Finalize draft Directive on restructured credit exposures as soon as possible.
- 20. Transactions with related parties
  - Amend Regulations so the Registrar can set limits on exposures to any related parties.
- 23. Interest rate risk in the banking book
  - Continue plans to further strengthen review of banks’ internal interest rate risk measurement systems.
- 28. Disclosure and transparency
  - Review Pillar 3 disclosures consistently either by BSD internal staff or by requiring external auditors to do so.
- 29. Abuse of financial services
  - Proceed with planned revision of FICA to incorporate the risk-based approach to AML/CFT and ensure enforceability of essential elements currently in the FICA Guidance Notes.
  - Continue AML/CFT on-site inspections to cover all banks expeditiously and improve approaches based on lessons learned.

*Source: IMF assessment excerpt (as provided).*

### 41.      The FSB-SA has introduced a risk-based supervision framework, which has been

### _cr14340 - 41.      The FSB-SA has introduced a risk-based supervision framework, which has been

### Risk-based supervision: current status and recommendations
- The FSB-SA has introduced a risk-based supervision framework that is evolving to improve supervisory intensity and effectiveness.
- Scope for more intensive on-site visits with a baseline supervision cycle proportionate to the risk profiles of insurers and reinsurers.
- Recommend a systematic approach to evaluating the nature of supervision of reinsurers and other counterparties used by insurers.
- Group supervision should:
  - cover all insurance groups with holistic off-site monitoring of intra-group transactions and aggregate group exposures;
  - include joint on-site visits of financial conglomerates.
- To improve supervisory effectiveness the FSB-SA is advised to:
  - strategize an appropriate risk-based supervisory cycle to cover the large number of FSPs;
  - adopt a more structured macro-prudential surveillance framework that considers cross-sectoral inter-linkages and system-wide market conduct issues.

### Regulatory updates, gaps, and fine-tuning priorities
- Authorities have made good progress updating/formalizing the regulatory regime in line with IAIS standards.
- Areas for fine-tuning:
  - a) A proportionate licensing and supervisory approach for friendly societies and clearer boundaries between medical schemes and insurance products;
  - b) Priority of ranking for policyholders in the event of winding-up;
  - c) Enhance the proposed group supervision framework by establishing explicit requirements on intra-group transactions and risk exposures e.g., intra-group reinsurance;
  - d) Provide explicit CoB requirements on product development and provide the supervisor with the authority to require notification of certain types of new insurance products and prohibit certain products that do not meet prescribed standards;
  - e) Public disclosure requirements for all insurers and clear legal authority to supervise compliance;
  - f) Address the remaining legal deficiencies in the AML-CFT regime;
  - g) Appropriate indicators for assessing systemic risk of insurers and reinsurers;
  - h) A crisis management and resolution framework to deal with cross-border crisis effectively.

### Institutional strengthening of FSB-SA pending Twin Peaks
- Pending the implementation of the Twin Peaks, the FSB-SA could be further strengthened by:
  - a) formalizing the objectives for insurance supervision and the legal authority for group-wide supervision in the legislation;
  - b) strengthening operational independence to minimize undue political or industry interference;
  - c) reviewing the adequacy of supervisory resources and augment skill sets in light of current and impending regulatory initiatives.
- Continued positive engagement with domestic and international counterparts is important to ensure effective supervisory cooperation.

### Summary of compliance with the Insurance Core Principles (ICPs) — key points by ICP
- 1. Objectives, Powers and Responsibilities of the Supervisor
  - The FSB-SA is the primary authority responsible for insurance supervision and its powers are clearly defined in legislation.
  - Objectives are not explicitly stated in legislation, but the Mission and Vision statement of the FSB-SA gives effect to the objectives of insurance supervision.
  - Authorities have made good progress in identifying changes required to align supervision with international standards.

- 2. Supervisor
  - Governance structure and Board are adequately defined including internal governance procedures.
  - Some Board members are related to regulated entities and may not be fully independent from commercial interests.
  - FSB-SA consults widely on regulatory reforms.
  - Significant resources added to the Insurance Division over the last four years; additional skilled staff will be needed to implement regulatory reform agenda and supervise complex conglomerates.

- 3. Information Exchange and Confidentiality Requirements
  - FSB-SA empowered to coordinate, collaborate and share information with domestic and foreign regulators and does so with appropriate regard for confidentiality.
  - Written agreement or strict reciprocity is not required for information exchange.
  - FSBA amended recently to further facilitate information exchange and strengthen confidentiality requirements.

- 4. Licensing
  - Licensing framework is clear and transparent with mechanisms including the Licensing Committee and rights of appeal.
  - Current legislation does not specifically include licensing requirements relating to governance, risk management and group structure; Risk-Based Supervisory Framework practices inform licensing decisions.

- 5. Suitability of Persons
  - Suitability requirements apply to board of directors, senior management and significant owners.
  - Key Persons in Control Functions are not covered directly (ICP 8); gap to be addressed in upcoming proposed Board Notice.
  - FSB-SA compensates partly via Risk-Based Supervisory Framework practices.

- 6. Changes in Control and Portfolio Transfers
  - Insurance Acts set clear ownership and control thresholds requiring approval.
  - FSB-SA can approve or deny proposals for portfolio transfers and acquisitions of controlling interests, assessed on same criteria as new license applications and considering policyholder interests.
  - Insurers are not explicitly required to notify FSB-SA of significant decreases in ownership below pre-determined control levels, but such cases are usually identified through risk-based supervision.

- 7. Corporate Governance
  - No explicit corporate governance requirements in the Insurance Acts or regulations.
  - FSB-SA relies on registration requirements as high-level legal basis to supervise governance practices and reviews governance through qualitative questionnaires and on-site discussions.
  - Board Notice in process to establish explicit governance requirements; comprehensive group-level corporate governance framework expected to be implemented in 2016.

- 8. Risk Management and Internal Controls
  - Insurance Acts/supervisory guidelines do not specifically require insurers to establish effective systems of risk management and internal controls.
  - No explicit requirements for risk management, compliance and internal audit functions; King III partly addresses internal audit on an apply-or-explain basis.
  - FSB-SA reviews risk management and internal controls as part of risk-based supervision; proposed Board Notice will establish comprehensive provisions.

- 9. Supervisory Review and Reporting
  - Risk-based approach helps prioritize supervisory focus and allocate resources.
  - Adequate documentation and follow-up for off-site monitoring and on-site visits; continuous refinement of risk-based supervisory process.
  - Need for more standardized reporting of intra-group transactions and aggregate risk exposures, including joint inspections for all insurance groups.
  - Absence of group market conduct requirements needs further attention.
  - Planned introduction of a dedicated quarterly CoB return for supervisory monitoring and enforcement is a positive step.

- 10. Preventive and Corrective Measures
  - Insurance Acts and the Financial Institutions (Protection of Funds) Act provide a wide range of remedies to address non-compliance.
  - Risk-Based Supervisory Framework supports early intervention and progressive escalation of remedial measures.
  - FSB-SA has adequate powers for timely and proportionate preventive and corrective measures.

- 11. Enforcement
  - FSB-SA has a wide range of enforcement powers, frequently applied in practice.
  - Enforcement Committee (EC) adjudicates alleged contraventions and can impose unlimited penalties, compensation orders and cost orders.
  - Criteria guiding sanctions are clear, objective and publicly disclosed.
  - In practice, FSB-SA has taken enforcement actions against several insurers, including the three insurers that failed.

- 12. Winding-up and Exit from the Market
  - Insurance Acts provide clear triggers for action when an insurer becomes financially unsound.
  - Winding-up regime tested with the failure of three insurers in the past five years.
  - Policyholders do not currently have priority of claims over unsecured creditors in winding-up.
  - FSB-SA participating in a Resolution Policy Working Group considering improvements including the establishment of a policyholder protection scheme.

- 13. Reinsurance and Other Forms of Risk Transfer
  - FSB-SA reviews proposed reinsurance arrangements during licensing; insurers may obtain relief for “approved reinsurance policy” when calculating technical provisions.
  - Ongoing regulatory requirements on reinsurance operations, including intra-group reinsurance, have not been established.
  - No regulatory policy on treatment and accounting for alternative risk-transfers (ART).
  - FSB-SA reviews reinsurance in off-site analysis and verifies during on-site visits but does not specifically assess cedants’ liquidity management with respect to reinsurance.

- 14. Valuation
  - Valuation regime is prudently realistic, based on financial reporting standards with prudential filters and prudent valuation methodologies for assets and technical provisions prescribed by FSB-SA.
  - Long-term insurers must observe ASSA standard actuarial practices and use best-estimate assumptions, consider policyholders’ reasonable expectations and maintain explicit compulsory and discretionary margins.
  - Short-term insurers have no requirement for an explicit margin over current estimate; an implicit margin is incorporated via prudent factors and a policy of no discounting.

- 15. Investment
  - Requirements exist on eligible assets; diversification; non-admitted assets for solvency; prohibition against encumbrances; use of nominees; and investments in derivatives.
  - Proposed Board Notice will require an explicit investment policy and explicit asset-liability management (ALM) policy.

- 16. Enterprise Risk Management for Solvency Purposes
  - Pending SAM implementation, Insurance Acts and guidance do not address ERM and ORSA regulatory requirements.
  - Interim measures: semi-annual economic STs for the six largest long-term and short-term insurers, and annual economic and insurance ST for all insurers.
  - FSB-SA reviews ERM frameworks and monitors ORSA progress.
  - The Pillar II Readiness exercise in 2012 found that almost 85 percent of insurers were either weak or needed improvement with respect to ORSA preparations; a follow-up Pillar II readiness review is underway.

- 17. Capital Adequacy
  - Current solvency regime is transparent and more risk-based for long-term insurers than short-term insurers.
  - CAR has been largely sufficient in preventing insurer failures or losses to policyholders, aided by prudence in technical provisions.
  - Insurance laws provide a single point of supervisory intervention; continuous monitoring allows early identification of potential CAR breaches and facilitates timely intervention.

- 18. Intermediaries
  - Detailed requirements for licensing FSPs with risk-based ongoing supervision.
  - Adequate requirements for professional and transparent conduct, disclosure, and protection of client funds.
  - Actions taken against unlicensed individuals and entities.
  - Mis-selling and poor outcomes persist; TCF initiative underway and being embedded into regulatory and supervisory framework, including explicit minimum governance requirements.

- 19. Conduct of Business
  - Processes exist to review fair treatment of customers before contract entry through contract conclusion.
  - Authorities are engaging market conduct participants to improve CoB practices and address regulatory gaps.

- 20. Public Disclosure
  - Insurance Acts do not have explicit public disclosure requirements; adoption of IFRS partly addresses ICP standards.
  - Unless listed, insurers are not obliged to make financial statements available beyond persons with a beneficial interest.
  - FSB-SA does not monitor disclosures to market participants.
  - Under SAM, public disclosure requirements will be established as part of Pillar III.

- 21. Countering Fraud in Insurance
  - FSB-SA has minimal direct legislative powers on insurance fraud; fraud is a criminal offence under common law and Criminal Law imposes sanctions.
  - FSPs required to address risks (including fraud) that result in financial loss to clients and others.
  - FSB-SA checks whether insurers and FSPs have implemented fraud prevention measures, though no thorough examination has been conducted.

- 22. Anti-Money Laundering and Combating the Financing of Terrorism
  - AML-CFT legislative framework comprises the FICA, the MLTFC Regulations and Exemptions in Terms of the FICA.
  - AML-CFT regime covers long-term insurers and FSPs; FIC has issued directives and Guidance Notes.
  - Some parts of FIC guidelines are not legally enforceable due to legal gaps in AML-CFT regime.
  - FSB-SA is a designated AML-CFT competent authority, empowered to conduct AML-CFT on-site inspections and impose administrative sanctions.
  - Assessing compliance by long-term insurers and FSPs is embedded in FSB-SA’s risk-based supervision.
  - Insurers and FSPs submit suspicious transactions reports to the FIC directly.
  - FSB-SA authorized to cooperate and exchange information and has a MoU with the FIC.
  - Disclosure of information to a foreign FIU may only be provided pursuant to a written agreement and subject to reciprocity.

- 23. Group-wide Supervision
  - FSB has been developing its approach to group supervision; in practice group-wide supervision is informal and relies on general authority and standing rather than specific legislative provisions.
  - FSB-SA cooperates and coordinates conglomerate supervision with the SARB on systemic issues regularly.
  - Focus to date has been on a few large conglomerates; supervision relies mainly on some financial indicators.

- 24. Macroprudential Surveillance and Insurance Supervision
  - FSB-SA uses supervisory analysis and external sources to assess how macro-economic vulnerabilities and financial market risks affect insurers and sector stability.
  - No formal process to assess potential systemic importance of insurers; major and potentially systemic insurance groups supervised more closely.
  - Under proposed Twin Peak structure, the SARB will serve as the macro-prudential supervisor.

- 25. Supervisory Cooperation and Coordination
  - Despite lack of a formal framework, FSB-SA coordinates and cooperates with other supervisors in practice through general standing and willing participation of insurance groups.
  - FSB-SA has hosted one supervisory college as group-wide supervisor and plans to host supervisory colleges for four other insurance groups for which it is the de-facto group-wide supervisor.
  - Legislative provisions are pending to enhance the framework for cooperation and coordination in group-wide supervision.

*Source: _cr14340 - 41.      The FSB-SA has introduced a risk-based supervision framework, which has been*

### 26.   Cross-border

### 26.   Cross-border

### Overview of cross-border crisis management
- The FSB-SA has demonstrated its ability and willingness to support and participate in resolving crisis situations.
- Pre-crisis preparation, coordination and cooperation should be enhanced.
- The current legislative framework does not hinder cooperation and coordination in a crisis, but identified gaps should be addressed to facilitate more effective cross-border crisis management.

### Key recommendations relevant to cross-border crisis management (extracted from Insurance Core Principle Recommendations)
- 1. Objectives, Powers and Responsibilities of the Supervisor
  - Expedite finalization of the proposed Financial Sector Regulation Bill and the Insurance Bill that establish the objectives of insurance supervision and confer legal authority on the FSB-SA to conduct group supervision.
- 2. Supervisor
  - a) Revise criteria for appointment of Board members to ensure there is no undue political or industry interference.
  - b) Expedite legislative amendments to have explicit legal provisions regarding the appointment and dismissal of the head of the supervisor and members of its governing body.
  - c) Review the adequacy of supervisory resources.
  - d) Consider exempting the supervisors from the government’s austerity measures and administrative guidance.
  - e) Consider how best to enhance the effectiveness of the internal audit functions.
- 4. Licensing
  - Expedite legislative amendments to formalize licensing requirements relating to governance, risk management and group structure.
  - Review current exemptions for friendly societies and adopt proportionate approach for these entities.
  - Formulate clearer boundaries between medical schemes and insurance products that should be supervised under the Insurance Acts.
- 6. Changes in Control and Portfolio Transfers
  - Introduce a definition of “significant” owner based on control and percentage.
  - Expedite legislative amendments to authorize the FSB-SA to approve any significant increase above the predetermined control levels and to approve any significant decreases as well.
- 7. Corporate Governance
  - Implementation of the proposed Board Notice, the Financial Sector Regulation Bill and the Insurance Bill will address current regulatory gaps.
  - FSB-SA should plan for adequate supervisory resources to implement the enhanced corporate governance framework effectively.
- 9. Supervisory Review and Reporting
  - Ensure that three year supervisory cycle is completed for all insurers and reinsurers.
  - More intensive on-site visits for the more complex insurers.
  - Require an appropriate group supervision plan covering all insurance groups in a risk-based proportionate manner, including joint on-site visits of financial conglomerates.
  - Increase off-site monitoring of intra-group transactions and aggregate group exposures and limits.
  - Establish procedures for insurer/groups to report group related risks and risk direction for off-site monitoring.
  - Institute procedures to capture CoB risks in the current RAD such that both prudential and CoB supervision form part of the risk assessment and ensure adequate skilled supervisory resources are in place.
- 12. Winding-up and Exit from the Market
  - Expedite changes to the legislative framework such that high legal priority is given to the protection of the rights and entitlements of policyholders.
- 13. Reinsurance and other Forms of Risk Transfer
  - Implement the proposed Board Notice to address most regulatory gaps on reinsurance.
  - a) Adopt a systematic approach to evaluating the nature of supervision of reinsurers and other counterparties used by insurers.
  - b) Formulate clear policy position on the treatment and accounting for ART.
  - c) Establish explicit requirements on reinsurance with related companies, including management of liquidity, concentration, and contagion risk as well as potential conflicts of interests.
  - Assess acceptability of reinsurance with related companies based on both qualitative (e.g., purpose) and quantitative criteria.
- 14. Valuation
  - The valuation regime under the SAM Framework will be based on economic valuation, with explicit margins over current estimate for technical provision.
- 15. Investment
  - Proposed Board Notice provisions governing insurers’ investment activities and ALM will address most current regulatory gaps.
  - Authorities are advised to formulate appropriate investments requirements at the insurance group level.
- 16. Enterprise Risk Management for Solvency Purposes
  - Proposed Board Notice covering risk management and the implementation of the SAM Framework will significantly enhance the regulatory regime for ERM.
- 17. Capital Adequacy
  - The impending implementation of the SAM Framework and the Insurance Bill, including financial soundness requirements for insurance groups, will bring the solvency regime in line with ICP 17.
- 18. Intermediaries
  - Actively monitor persistence rates of intermediaries.
  - Ensure governance requirements for intermediaries are effectively embedded and enforced.
  - Consider ways to simplify the FSP structure to focus supervision of insurance intermediaries to improve policyholder protection.
  - Consider establishing cyber-surveillance to detect and prevent illegal sale of insurance products via internet, social networking services, and mobile telephony.
  - Ensure adequate resources for robust implementation of recent legislative amendments and effective supervision of intermediaries.
- 19. Conduct of Business
  - Expedite current CoB initiatives to address gaps, including:
    - Explicitly require insurers to take into account the interests of different types of customers when developing and marketing insurance products.
    - Provide explicit CoB requirements on insurance product development and provide the supervisor authority to require notification of certain types of new insurance products and prohibit certain products that do not meet prescribed standards.
    - Strengthen governance framework on conflicts of interest.
    - Review adequacy of supervisory resources.
- 20. Public Disclosure
  - Establish explicit public disclosure requirements in line with ICP 20 that are applicable to all insurers and provide clear legal authority to the FSB-SA to supervise compliance.
- 21. Countering Fraud in Insurance
  - Proposed Board Notice will require insurers to establish an explicit insurance fraud risk management policy, including prompt reporting to the relevant authorities, in line with ICP 21.
- 22. Anti-Money Laundering and Combating the Financing of Terrorism
  - Proposed Board Notice will enhance measures insurers must take in respect of managing risks associated with ML-FT.
  - a) Expedite passage of amendments to the main AML-CFT legislation to address remaining technical deficiencies.
  - b) Consider how best to improve supervisory coordination and engagement of the industry to facilitate effective compliance by insurers and FSPs with their AML-CFT obligations.
  - c) Periodically assess the potential ML-FT risk in the short-term insurance industry and consider whether to apply the FINANCIAL ACTION TASK FORCE standards to short-term insurance.
- 23. Group-wide Supervision
  - Establish clear and consistent regulatory regime for group-wide supervision to provide explicit powers to enforce group-wide supervision (including reporting requirements at both solo and consolidated levels).
  - Approve intra-group transactions and cross-shareholdings to prevent concentration risk, risk of contagion, and double gearing of capital.
  - Implement a more formal risk assessment program for heads of group and group-wide market conduct requirements.
  - Enhance and formalise cross-sectoral coordination mechanisms, particularly with respect to groups majority-owned by securities entities.
- 24. Macroprudential Surveillance and Insurance Supervision
  - Formulate macro-prudential surveillance framework appropriate to the nature, scale and complexity of the insurance sector under the Twin Peaks supervisory structure.
  - Consider developing more robust indicators for assessing systemic risk of insurers and reinsurers.
  - Take account of cross-sectoral linkages, e.g., cross-shareholdings across the sectors, bancassurance, linked policies.
  - Include risks arising from system-wide market conduct issues, including reputational risks.
- 26. Cross-border Cooperation and Coordination on Crisis Management
  - Continue to engage relevant supervisory colleges on preparations and common tools for managing a cross-border crisis.
  - Identify and resolve barriers to efficient and internationally coordinated resolutions.
  - Use work of the Resolution Policy Working Group to inform formulation of a crisis management and resolution framework that deals with cross-border crisis effectively.
  - Framework should explicitly address:
    - Plans and tools for dealing with insurers in crisis.
    - Requirements for insurers to provide information in a timely fashion.
    - Requirements for insurers to maintain contingency plans and procedures which should be tested and reviewed regularly.

### Authorities’ response (selected)
- 44. The FSB-SA thanked the Assessors for the report on the detailed assessment of the IAIS Insurance Core Principles and stated the report is comprehensive and displays a good understanding of the FSB-SA regulatory and supervisory frameworks (both existing and planned). The assessment was described as an extremely useful exercise in terms of providing an independent and objective benchmarking of the standards of insurance regulation and supervision in South Africa against international standards.
- 45. The FSB-SA noted the report accurately reflects ways in which the FSB-SA is already well-advanced in addressing some identified gaps in the regulatory framework and supervisory practices, and that the assessment was a useful tool in refining regulatory and supervisory framework enhancements currently underway.

*Source: _cr14340 - 26.   Cross-border*

### 59.      Since the last IOSCO assessment, two new relevant Acts have come into force. On June

### _cr14340 - 59.      Since the last IOSCO assessment, two new relevant Acts have come into force. On June

### Legislative and regulatory changes
- Two new Acts came into force:
  - On June 3, 2013, the FMA replaced the Securities Services Act (SSA). The FMA:
    - focuses on licensing and regulation of market infrastructures (exchanges, CSDs, clearing houses and trade repositories) and on the prohibition of insider trading and other market abuses.
    - provides a framework for regulating OTC derivatives in South Africa under regulations that can be issued by the MoF.
  - The Credit Rating Services Act (CRSA) came into effect on April 15, 2013. It introduced a framework for the registration and supervision of CRAs in South Africa.
- The General Amendment Act came into force on February 28, 2014, and amended all Acts applicable to FSB activities, including:
  - aligned the supervisory powers of the Registrar,
  - provided for enhanced protection of information and sharing of information provisions,
  - clarified and extended the consumer education and protection mandate of the FSB,
  - extended the Registrar’s powers to act swiftly to prevent the failure of any financial institution.

### Market structure and market infrastructures
- Exchange and clearing:
  - The JSE is the only securities exchange in South Africa. It is a public company listed on the JSE main list.
  - SAFCOM, a wholly-owned subsidiary of the JSE, clears JSE derivatives transactions.
  - The JSE manages the pre-settlement process for equities trades and can require margin to cover open positions.
  - Settlement of equity and bond trades takes place at Strate, the CSD for both markets.
  - Strate ownership: JSE (44.6 percent) and the four largest South African banks each owning 12–15 percent. Citibank owns 0.1 percent of Strate’s shares.
  - SAFCOM does not have any self-regulatory responsibilities because it is an associated rather than an independent clearing house under the FMA.

### Key market statistics (selected figures from Annex Table 1)
- Shares (12/2011, 12/2012, 12/2013):
  - Number of listed shares: 406, 402, 389
  - Market capitalization (billion USD): 1,175; 988; 1,015
  - Market capitalization as percent of GDP: 191.3; 267.09; 291.97
  - Market capitalization of top 10 issuers (billion USD): 414; 474; 546
  - New listings: 16; 14; 13
  - Annual turnover (billion USD): 454; 419; 409
  - Annual turnover of top 10 issuers (billion USD): 229; 198; 186
  - Average daily trading volume (number of shares): 287,019,977; 247,374,883; 255,567,541
  - Average daily turnover (million USD): 1,823; 1,674; 1,635
- Bonds (12/2011, 12/2012, 12/2013):
  - Number of listed bonds: 135; 152; 133
  - Market capitalization (billion USD): 184; 221; 188
  - Market capitalization as percent of GDP: 50.71; 59.60; 54.10
  - New listings: 732; 896; 815
  - Annual turnover (billion USD): 2,883; 2,801; 2,001
  - Average daily turnover (million USD): 11,579; 11,203; 8,002
- Equity derivatives (12/2011, 12/2012, 12/2013):
  - Annual turnover (billion USD): 598; 515; 520
  - Average daily trading volume (number of contracts): 597,682; 547,894; 869,886
  - Average daily turnover (million USD): 2,400; 2,061; 2,078
  - Number of exchange members: 126; 126; 120
- Interest rate and currency derivatives:
  - Annual turnover (billion USD): 43; 55; 78
  - Average daily trading volume (number of contracts): 60,681; 77,631; 152,835
  - Average daily turnover (million USD): 171; 220; 314
- Commodity derivatives:
  - Annual turnover (billion USD): 55; 62; 50
  - Average daily trading volume (number of contracts): 11,513; 11,998; 11,153
  - Average daily turnover (million USD): 219; 249; 201

### JSE membership and ownership
- JSE members:
  - The number of JSE members has remained stable over the past three years.
  - Equities members (2011, 2012, 2013): 63; 61; 62
  - Equity Derivatives members and clearing members: 126 (9); 126 (9); 120 (10)
  - Interest Rate and Currency Derivatives members and clearing members: 98 (6); 98 (6); 102 (6)
  - Commodity Derivatives members and clearing members: 100 (5); 100 (5); 92 (5)
  - Bonds members: 46; 47; 49
  - Note: Number of clearing members in each category shown in brackets; there are no clearing members on the Equities Market.
- Cross-border activities:
  - Direct membership by foreign firms on the JSE is prohibited.
  - The most active equities trading members are subsidiaries of foreign investment banks.
  - Foreign subsidiaries of member firms are not regulated by the JSE, so it does not have routine access to information on these activities.
  - Local members do not appear to have significant operations abroad.
- Ownership of JSE equity firms (Percentage of Firms):
  - Local banking groups: 19
  - Local listed companies: 8
  - Local insurance groups: 6
  - Local private ownership: 40
  - Foreign banking groups: 19
  - Foreign investment firms: 8
  - Aggregate statements:
    - Domestic private or listed companies own almost half the firms (48 percent).
    - 25 percent are owned by domestic banks or insurance companies.
    - 27 percent are owned by foreign banks or investment firms.

### Other intermediaries and FSP licensing
- FSPs licensed under the FAIS Act (number of firms as of March 31):
  - Category I (Advisers and others): 11,322; 10,333; 10,164; 10,152 (2011, 2012, 2013, 2014)
  - Category II (Discretionary): 551; 561; 585; 613
  - Category IIA (Hedge Fund): 117; 118; 117; 113
  - Category III (Administrative): 23; 22; 24; 27
  - Category IV: 38; 56; 68; 87
  - Total number of authorized firms: 12,051; 10,790; 10,958; 10,992
  - The decline in Category I FSPs attributed to consolidation and increasing costs of compliance.

### Collective Investment Schemes (CIS) and assets under management (AUM)
- AUM and industry structure:
  - Fund management industry AUM reached ZAR 1.5 trillion (USD 161 billion) at the end of 2013.
  - These AUM were managed by 48 fund managers in a total of 1,084 portfolios.
  - MMFs represent 17 percent of total AUM in local CIS.
  - Unregulated hedge funds manage approximately USD 10 billion of assets, primarily in trusts and partnerships.
- Assets under Management in South African Collective Investment Schemes (Billion ZAR):
  - South African Funds: 956; 1,160; 1,373 (2011, 2012, 2013)
  - Equity: 214; 253; 297
  - Multi-asset: 283; 394; 627
  - Real Estate: 32; 47; 48
  - Money Market: 253; 245; 257
  - Other Interest Bearing: 173; 221; 143
  - Other Funds: 55; 70; 126
  - Total: 1,011; 1,230; 1,499
  - Source: ASISA.

### Preconditions for effective securities regulation
- Market access and authorization:
  - Foreign issuers can access the markets under similar conditions to domestic issuers, although this is infrequently done.
  - The authorization process does not distinguish between domestic and foreign intermediaries that want to provide investment services.
- Company and insolvency framework:
  - Companies legislation includes provisions on management, shareholder rights, duties of directors and officers, preparation and audit of accounts, proceedings of shareholder meetings, and detailed takeover rules administered by the TRP.
  - New provisions facilitate restructuring finances and operations to avoid liquidation.
  - The Insolvency Act (Act No. 24 of 1936) has been updated to address protection of customers’ assets held by intermediaries and to give exchanges and clearing systems the ability to close out or unwind incomplete transactions on the insolvency of a market participant.
- Courts, accounting and auditing:
  - Dedicated independent tribunals and courts deal with securities-related matters; judiciary independence protected by the Constitution; specialized commercial crimes court exists.
  - All public companies are required to prepare financial statements in accordance with the IFRS as issued by the IASB.
  - The ISA issued by the IAASB have been officially adopted.

### Main findings (summary of Principles 72–79)
- Principles for the regulator:
  - Securities regulatory and supervisory responsibilities are defined in various Acts and allocated to several authorities and market infrastructures, including within the FSB where different Divisions led by Deputy Registrars operate fairly independently.
  - The complex division of responsibilities may lead to regulatory gaps and inconsistencies.
  - Supervisory cooperation exists and includes monitoring systemic risk and assessing the regulatory perimeter, but optimal structures are not yet in place.
  - The FSB has sufficient powers, authority and funding; ensuring sufficient staff expertise in the transition to the new Twin Peaks structure is a challenge.
  - There may be an appearance of undue political or commercial influence in FSB decision-making due to the current ministerial appointment process and certain governance arrangements.
  - Some FSB internal policies and practices require strengthening and harmonizing across the organization.
  - There are requirements to address conflicts of interest of supervised entities.
- Principles for self-regulation:
  - The JSE and Strate are under statutory obligations to undertake certain important self-regulatory responsibilities; intermediary activities covered by their supervision are exempt from FSB supervision.
  - The FSB assesses their self-regulatory capacity and arrangements upon licensing and on an ongoing basis.
  - Conflicts of interest between the JSE’s and Strate’s commercial and self-regulatory functions must be managed satisfactorily to the FSB.
- Principles for enforcement:
  - The FSB has broad powers to inspect, investigate and conduct surveillance of securities markets and activities and comprehensive powers to take action against breaches.
  - The FSB’s risk-based system drives its supervisory program (off-site supervision and on-site inspections including full reviews, thematic reviews, and ad-hoc visits).
  - The FSB’s EC has wide powers to impose sanctions and has obtained significant monetary sanctions; all sanctions imposed by the EC are published as are most others imposed by the Registrars.
  - Criminal cases have been referred for investigation and prosecution, but very few have led to convictions.
  - Record-keeping requirements under CISCA are minimal and the depth of CIS supervisory activities could be enhanced.
- Principles for cooperation:
  - The FSB can share information and cooperate domestically and internationally; it is a signatory to many MOUs, including the IOSCO MMOU and several bilateral MOUs.
  - The FSB participates in several domestic supervisory colleges involving financial groups.
  - It does not require permission of any outside authority to share or obtain information, nor an independent interest in the matter to assist.
- Principles for issuers:
  - Initial disclosure requirements for securities to be listed on the JSE are satisfactory, as are most continuous disclosure requirements.
  - Significant gaps exist for unlisted public companies (e.g., no requirement to provide public disclosure of material changes or prepare interim financial statements).
  - Reporting deadlines for financial statements are slow by international standards, although JSE issuers report more promptly in practice.
  - Public company shareholders are treated equitably with respect to voting and participation in takeover bids; full information must be provided for any takeover bid and the price paid must be equivalent.
  - Extensive disclosure requirements apply for substantial shareholders, directors and other parties.
  - All public companies must prepare financial statements in accordance with the IFRS as issued by the IASB; processes exist to review financial statements to ensure standards are met.
- Principles for auditors, CRAs, and other information service providers:
  - IRBA supervises auditors of public companies (registration, inspection, and discipline).
  - IRBA’s independence could be enhanced by a broadened funding model and limitations on auditor participation on its governance bodies.
  - Extensive requirements exist for auditor independence; these are enforced by IRBA.
  - Financial statements of public companies must be audited in accordance with the ISA as issued by the IAASB.
  - The regulatory framework for CRAs complies with international standards and the FSB is launching its CRA supervisory program.
  - Analytical or evaluative service providers are not relied on and are not required to be authorized.
- Principles for collective investment schemes:
  - Regulatory requirements apply to registration of CIS managers and trustees and approval of the CIS deed.
  - Regulation of conflicts of interest, record-keeping and CoB is insufficiently granular.
  - The FSB’s intensity of supervision on CIS managers and trustees would benefit from enhancement.
  - CIS are subject to investment limits and restrictions; managers are required to segregate client assets and funds; related party custody is prohibited in practice.
  - Limited public disclosure requirements apply to CIS and accounting standards for CIS are not specified.
  - Valuation of CIS assets is largely regulated in a very general manner, leaving significant room for discretion and placing responsibility for appropriate valuations on trustees.
  - MMFs apply constant NAV and permit longer maturity investments than recommended by IOSCO.
  - Hedge fund regulation complies with IOSCO minimum requirements via requirements imposed on the hedge fund manager as an FSP.
- Principles for market intermediaries:
  - A framework exists at the FSB and JSE for licensing and applying on-going requirements on market intermediaries.
  - License applicants undergo detailed fit and proper reviews.
  - There are initial and ongoing capital requirements for all types of intermediaries; the JSE’s capital formula is risk-based and timely reporting requirements apply; the JSE directly monitors members’ capital daily.
  - While certain categories of FSPs face higher minimum capital amounts, the capital formula for FSPs is not sensitive to the full range of risks and focuses on solvency and liquidity.
  - Routine reporting by these firms is limited.
  - Market intermediaries must have risk management and internal control systems, but there is no requirement that these systems be reviewed on behalf of the firm by an objective party.
  - Regulations address protection of clients (business conduct and segregation of clients’ assets).
  - No written plan exists at the FSB or JSE for dealing with a firm failure, but each has extensive powers to intervene to protect clients and the market.

*Source: _cr14340 - 59. Since the last IOSCO assessment, two new relevant Acts have come into force. On June (IMF PDF content).*

### 80.      Principles for secondary markets. Exchanges are subject to comprehensive regulatory

### _cr14340 - 80.      Principles for secondary markets. Exchanges are subject to comprehensive regulatory

### Secondary markets: key findings
- Exchanges are subject to comprehensive regulatory requirements as a condition for licensing and on an ongoing basis.
- The JSE, as the only exchange, is responsible for market surveillance and supervision of its members.
- The FSB performs detailed supervision of the JSE, conscious of the potential for regulatory capture arising from such close involvement.
- Sufficient pre- and post-trade transparency requirements apply under the JSE Rules.
- Insider trading, market manipulation and disclosure of false and misleading information are prohibited and subject to both administrative and criminal sanctions.
- Monitoring, investigations and enforcement require cooperation between several authorities.
- There has been only one criminal conviction for market abuse (fraud).
- The JSE closely monitors open positions in equity and derivatives markets and can take prompt action when needed.
- Covered short selling is permitted, but there are no disclosure requirements to the regulator or the market.

### Summary: Implementation of the IOSCO Principles — Findings (selected)
- Principle 1: The FSB’s and the Registrar’s regulatory and supervisory responsibilities are set out in the FSB Act, the Protection of Funds Act, the Inspection of Financial Institutions (Act No. 80 of 1998) and the various sectoral Acts. Legislation assigns specific responsibilities to the FSB Directorate of Market Abuse (DMA) and EC. Under the FMA, market infrastructures (the JSE and Strate) have important self-regulatory responsibilities. The Registrar has a wide exemption power; exercise of this power is not uniformly transparent across the FSB. Responsibilities for certain sectors are assigned to multiple authorities, creating a complex regulatory system with potential for gaps and inconsistencies. Cooperation arrangements aim at ensuring coordination.
- Principle 2: The MoF has extensive powers to appoint and remove the FSB Board, Appeal Board and DMA members and the majority of the Executive Committee members. Current appointment process may create the appearance of indirect political influence in FSB decision-making. FSB publishes an annual report, but there is no FSB wide approach to publication of supervisory and enforcement measures. FSB is funded through fees and levies from supervised entities; MoF approves the fees of the FAIS Registrar.
- Principle 3: The FSB has sufficient powers, authority and funding. Staffing level is appropriate for current functions, but attracting and maintaining sufficient expertise in certain areas has been a challenge. Decision-making powers largely delegated to Deputy Registrars and Divisions, conducive to a siloed approach.
- Principle 4: Sectoral Acts apply different requirements to rule-making processes; approaches across Divisions have largely converged. A new framework governing the FSB’s rule-making process is under preparation. Public access to legislation and FSB regulatory measures is incomplete due to subscription needs and website structure.
- Principle 5: FSB Staff Code of Conduct provides conflict of interest framework. Employment contracts prohibit FSB employees from holding or trading the shares of regulated entities; the Staff Code is less restrictive and does not apply to the FSB Board, Board Committee and DMA members.
- Principle 6: FMA assigns specific responsibilities to the Registrar and market infrastructures for systemic risk monitoring and cooperation. Processes to monitor, mitigate and manage systemic risk are being established and enhanced, including bilateral cooperation between FSB and SARB and multilateral activities of the FSCF. Limited discussions so far on systemic risk beyond trading and post-trading systems.
- Principle 7: Divisions have primarily concentrated on respective sectors when policing the regulatory perimeter; lacking a holistic process for reviewing the regulatory perimeter in relation to all products, entities and activities.
- Principle 8: Processes and requirements exist to address conflicts of interest and misalignment of incentives for FSPs, JSE and JSE members, and Strate and Strate participants.
- Principle 9: FMA assigns wide self-regulatory responsibilities to market infrastructures. The FSB assesses market infrastructures’ self-regulatory capacity through rule approval, reporting requirements, review of self-assessments and on-site visits. Specific requirements exist for managing conflicts between commercial and self-regulatory functions.
- Principle 10: FSB has broad powers to inspect, investigate and conduct surveillance. Record-keeping requirements under CISCA are minimal.
- Principle 11: FSB has comprehensive enforcement powers to investigate and take action; powers to take action against FSPs for non-compliance with other laws.
- Principle 12: FSB has a risk-based supervisory program with off-site supervision and on-site inspections. EC has wide powers to impose sanctions and has been successful in obtaining monetary sanctions largely through settlements. Most sanctions imposed by Registrars are published. Few criminal matters have led to convictions.
- Principle 13–15: FSB can share confidential information domestically and internationally; signatory to many MOUs including IOSCO MMOU; participates in domestic supervisory colleges; shares information under IOSCO MMOU without requiring permission of outside authority.
- Principle 16: Initial disclosure requirements for a public offer of securities to be listed on the JSE are satisfactory; significant disclosure gaps for unlisted public companies and unlisted entities offering securities to the public. Reporting deadlines for public company financial statements are slow by international standards, although JSE issuers report more promptly.
- Principle 17: Public company shareholders are treated equitably with respect to voting and takeovers. Extensive disclosure requirements for substantial shareholders, directors and other parties.
- Principle 18: All public companies in South Africa are required to prepare IFRS compliant financial statements. JSE reviews listed company financial statements; CIPC has started a similar program for unlisted public companies. IRBA conducts periodic reviews.
- Principle 19–21: Auditors of public companies are subject to appropriate oversight by IRBA. IRBA’s independence could be strengthened and resources are not sufficient. Auditors must register with IRBA and financial statements must be audited in accordance with the ISA as issued by the IAASB.
- Principle 22: Credit ratings used for regulatory purposes must be issued or endorsed by authorized domestic or foreign CRAs. CRSA and CRA Rules implement IOSCO Code. Four CRAs registered in South Africa, last two in early May 2014. FSB implementing supervisory plan.
- Principle 23: Analytical or evaluative service providers are not relied upon to any significant degree; research reports generally issued only by JSE member firms with limited circulation and impact. Research alone would not constitute ‘advice’ under FAIS Act or JSE Rules.
- Principle 24–27: CIS managers and trustees must be registered under CISCA; Registrar verifies CIS asset managers are authorized under FAIS Act. Registration of CIS manager conditional on Registrar approving CIS deed and supplements. FSB’s powers to supervise delegated activities recently enhanced. Regulation of conflicts of interest, record-keeping and CoB is insufficiently granular. On-site reviews of CIS managers exist but depth is limited; no on-site reviews of trustee activities. CISCA does not require particular legal form though in practice unit trusts are used. CIS valuation requirements are largely very general; MMF assets valued at amortized cost and maximum maturities permitted for MMF assets are longer than recommended by IOSCO. No regulatory requirements on pricing errors.
- Principle 28: Regulation of hedge funds relies on requiring hedge fund asset manager to be authorized as an FSP (meets IOSCO minimum). Hedge funds themselves are not regulated and there are no specific requirements on hedge fund administration. As FSPs, managers are subject to prudential, conflict of interest and client asset protection requirements.
- Principle 29–31: Framework exists at the FSB for licensing and on-going requirements for market intermediaries under FAIS Act. Initial and ongoing capital requirements exist for intermediaries. JSE members’ capital formula based on the EU Capital Adequacy Directive; JSE directly monitors equities members’ capital daily. Capital formula for FSPs is insufficiently risk-sensitive. Market intermediaries must have risk management and internal control systems; auditors must report annually on treatment of client assets. No compulsory periodic independent review of internal controls by an objective party.
- Principle 32: No written plan at the FSB for dealing with failure of an FSP; FSB has extensive powers to restrain conduct, ensure clients’ assets are properly managed and to appoint a curator via court. JSE has no plan, but extensive powers and guarantee funds available for losses at JSE member firms; not for FSPs. FSPs required to maintain professional indemnity and fidelity insurance.
- Principle 33–35: Exchanges must be licensed; licensing criteria set in FMA and Board Notice. JSE responsible for market surveillance and supervising members’ compliance. Sufficient pre- and post-trade transparency required by JSE Equities Rules; exceptions exist for hidden orders and certain off-order book trade types. According to JSE, most equities trading undertaken through central order book; all trades subject to immediate post-trade transparency.
- Principle 36: Insider trading, market manipulation and disclosure of false or misleading information are prohibited in FMA. Front running prohibition applies to FSPs; front running by exchange members not specifically addressed. Market abuse subject to administrative and criminal sanctions. JSE monitors potential market abuse and refers suspicious activity to the FSB. Administrative sanctions imposed; only one criminal conviction for market abuse.
- Principle 37: JSE closely monitors open positions in equity and derivatives markets and can act if a member cannot meet settlement obligations or margin. Default procedures in place and disclosed in JSE rules. Naked short selling prohibited; covered short selling defined narrowly. No reporting requirements to JSE, FSB or market on short selling; JSE and FSB do not undertake particular surveillance of short selling.

### Recommended Action Plan to Improve Implementation of the IOSCO Principles (selected recommendations)
- Principle 1
  - Ensure future Twin Peaks legislation harmonizes regulatory, supervisory and enforcement responsibilities and powers across sectors, supported by appropriate organizational structure and processes.
  - Ensure sufficiently harmonized regulatory requirements applied to economically equivalent products.
  - Make information on all exemptions granted available on the official website as required by Section 21 of the FSB Act.
- Principle 2
  - Ensure Twin Peaks legislation and governance arrangements provide sufficient political and commercial independence, including clear limitations on removal of members of governance bodies.
  - Government should remove requirement for the MoF to approve fees charged under the FAIS Act.
  - FSB should develop an FSB wide policy for publication of supervisory and enforcement measures.
- Principle 3
  - Ensure Twin Peaks legislation supports a more coordinated approach to supervision and decision making.
  - FSB should seek to maintain and attract sufficient expertise.
- Principle 4
  - Finalize and publish the code of norms and standards under section 18(3) of the FSB Act as soon as possible.
  - Harmonize FSB rule-making processes across sectors and include harmonized approaches to assessing cost of compliance.
  - Improve public access to legislation and FSB regulatory measures by posting copies on the FSB website and removing subscription requirements.
- Principle 5
  - Align requirements for holding and trading in securities in employment contracts and Staff Code of Conduct; ensure restrictions apply to all securities.
  - Apply securities holding and trading restrictions to all persons with access to confidential supervisory information, including FSB Board, Board Committee and DMA members.
- Principle 6
  - Develop holistic, organization-wide arrangements for monitoring, mitigating and managing systemic risk possibly arising from securities markets beyond trading and post-trading systems.
  - Ensure FSCF, FSOC and any future macroprudential function adopt a broad approach to analyzing systemic risks, including those from securities markets.
- Principles 7, 8 and 23
  - Establish a sufficiently holistic process to ensure products, entities and activities do not fall outside the regulatory perimeter.
  - Consider an FSB-wide proactive process to survey the marketplace to identify emerging conflicts of interest early.
  - Ensure the role of analysts and providers of evaluative services is part of the perimeter review process.
- Principle 10
  - Consider imposing more detailed record-keeping requirements for CIS managers.
  - CIS Registrar should have the same authority to demand any information from CIS managers as under the FMA and FAIS Act; amend CISCA accordingly.
- Principle 11
  - Align sanction publication practices of the CIS Division with other Divisions.
- Principles 12 and 24
  - FSB, particularly its Enforcement Unit, should continue building cooperative arrangements with criminal enforcement authorities.
  - Registrar of CIS should enhance depth of on-site visits of CIS managers and conduct on-site visits of CIS trustees.
- Principles 16, 18 and 20
  - Government should amend CA provisions to shorten the deadline for publishing audited annual financial statements to 120 days or less.
  - CA should require publication of interim financial statements at least semi-annually within a reasonable period after period end.
  - CA should require public companies to make prompt public disclosure of material changes, including a change in auditor.
  - JSE is encouraged to make the de facto 90-day deadline for audited financial statements a firm requirement and consider whether Altx issuers should adhere to the same time frame or be given somewhat longer.
  - JSE should consider shortening the reporting period for interim statements of JSE companies to 60 days or less.
- Principle 19
  - Government should expand IRBA’s authority to share information, particularly proactively with other regulators.
  - Consider enhancing IRBA independence by amending its funding model to include additional sources, such as levying a fee on public companies.
  - Consider reducing participation of registered auditors on IRBA committees responsible for investigations and disciplinary matters.
  - Include provisions permitting IRBA to indemnify directors and staff for legal costs.
- Principle 22
  - FSB should fully implement its supervisory plan with sufficient on-site visits and ongoing supervision of CRAs.
- Principle 24
  - FSB should significantly enhance conflict of interest, record-keeping and CoB requirements for CIS managers, in line with IOSCO Assessment Methodology and other sectors.
- Principle 25
  - Government should clarify drafting of prohibition of related party custody to ensure all related companies are excluded from providing trustee services to a CIS manager.
  - Authorities should consider enhancing requirements for the use of sub-custodians.
- Principle 26
  - Expeditiously require an offering document for all CIS.
  - Require CIS accounts to be prepared in accordance with high quality, internationally acceptable accounting standards.
  - Require the use of standard formats for CIS initial and periodic disclosures to investors.
  - Ensure sufficient requirements to identify inaccurate, false or misleading advertisements.
- Principle 27
  - Significantly enhance regulatory requirements on valuation of all types of CIS assets and determine high quality accounting standards for such valuations.
  - FSB should consider whether constant NAV MMFs may be converted to floating/variable NAV funds or introduce additional IOSCO-recommended safeguards to permit constant NAV.
  - Ensure sufficient regulatory requirements for disclosure of CIS unit prices and frequency of calculating CIS NAV; treatment of pricing errors should be explicitly regulated.
- Principle 30
  - FSB should adopt a more risk-sensitive capital formula for FSPs that varies directly based on risks undertaken, with higher requirements for riskier activities and larger positions; exposures to related companies should be deducted when calculating capital.
  - Require FSPs to update accounting records more timely and more frequent capital reporting for all FSPs except those carrying only limited activities.
  - Consider including an early warning obligation requiring immediate notice to FSB when firm’s capital declines below an early warning threshold, such as 10 percent over the minimum required, or other material adverse changes.
  - JSE should consider amending capital requirements to address exposures to off-balance sheet transactions and any related company.
- Principle 31
  - FSB and JSE should require FSPs and members to have periodic independent reviews of internal controls by an external expert such as an auditor.
  - Examine division of responsibility for supervision of JSE members that are also FSPs to avoid gaps or duplication.
  - Routinely share inspection reports regarding firms that are JSE members and FSPs.
  - Consider requiring written account agreements for all accounts.
- Principle 32
  - Each of the FSB and JSE should have written plans outlining actions and responsibilities if a regulated entity is in financial difficulty.
- Principle 36
  - FSB, SAPS and NPA should continue working to enhance use of criminal enforcement to combat market abuse.
  - Government is encouraged to consider extending insider trading prohibition to unlisted derivatives with a listed security or derivative as underlying instrument.
- Principle 37
  - JSE and/or FSB should introduce a short selling reporting regime and increase monitoring of short selling activities.

*Source: _cr14340 - 80.      Principles for secondary markets. Exchanges are subject to comprehensive regulatory*

### 81.      NT would like to express its appreciation for the report on the detailed assessment of the

### Paragraph 81 — South Africa response to detailed assessment of the IOSCO objectives and principles of securities regulation

### Overall appraisal
- South Africa (NT) expresses appreciation for the report on the detailed assessment of the IOSCO objectives and principles of securities regulation.
- The report is described as "very comprehensive" and as displaying a "good understanding of the FSB and other regulators and market infrastructure responses."
- The report is characterized as "balanced, constructive" and containing sections "useful for purposes of future improvements on the areas that have been identified for enhancement."
- Enhancement measures may take various other forms not necessarily mentioned in the report.

### Ratings and comments
- South Africa has not questioned any of the ratings.
- Comments have been provided for consideration on certain principles.

### Concern about assessment consistency
- The FSB (supervisor) raised concerns with the FSAP team about a possible lack of consistency in the assessment methodology of principles between the "2008 and 2014 FSAPs."
- The document makes specific reference to the CIS assessments, where there had been downgrades even though "neither the principles nor the legislation and practice changed over the 6 year period."
- South Africa observes that "it could be argued that had the grading in 2008 been similar to 2014, measures would have been put in place to address the shortcomings."

*Source: Paragraph 81 of the provided IMF FSAP content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14340.pdf_