The Financial Advisory and Intermediary Services Act 37 of 2002 (“FAIS”) regulates the provision of financial advice and intermediary services in respect of financial products. Although FAIS has a broad scope of application, the main industry role players include financial advisors and asset managers. An entity becomes a financial services provider (“FSP”) when it registers for a FAIS licence, and a representative (natural or juristic) must accordingly act behalf of the FSP. In the case of a juristic representative, the juristic representative requires its own representative (natural person) to act on its behalf and ultimately on behalf of the FSP.
The use of a juristic representative has come under scrutiny by the regulatory authority, the Financial Sector Conduct Authority (“FSCA”), due to the practice of “renting out” the FAIS licences. In this case, the primary FSP rents out its FAIS licence to another separate second entity acting as its “juristic representative” for a fee. The second entity is not under supervision of the primary FSP and often acts on its own accord without being a true representative of the FSP. The primary FSP has this arrangement with multiple entities which can then operate legally under FAIS and thereby circumvent the regulatory requirement to obtain their own FAIS licence which imposes its own onerous obligations.
Recent amendments to the determination of fit and proper requirements for FSPs of the FAIS Act under Board Notice 194 of 2017 such as additional capital adequacy requirements for juristic representatives placed enhanced requirements on juristic representatives. The amendments are indicative of the increased scrutiny on these licence “renting out” arrangements through the use of juristic representatives. It seems as if the juristic representative ride may be coming to an end with the implementation of the Conduct of Financial Institutions (“COFI”) Bill.
The implementation of the twin peaks model of financial regulation has been the focus for financial regulatory authorities because it is regarded as global best practice since the 2008 financial crisis. The twin peaks model was finalised with the enactment of the Financial Sector Regulation Act 9 of 2017 (the “FSR Act”) and is hailed as one of the most significant regulatory changes to the financial services industry in South Africa in decades. The COFI bill is a further twin peaks step to regulate market conduct and it will repeal the FAIS Act in its entirety.
Schedule 3 of the second draft of the COFI Bill refers to the activities of representatives of those entities that hold a licence under COFI. It prescribes the institutional form for those representatives and notes that for “discretionary investment management” (or asset management) which is currently a category II or IIA FSP licence under the FAIS Act, only a natural person may be a representative.
Schedule 3 makes a distinction for activities that are currently under the category I FSP licence, namely advice and intermediary services. For distribution activities, the description of “distribution” under COFI closely resembles “intermediary services” under the FAIS Act, and it allows any institutional form (natural or juristic person). For advice activities, the description of “advice” under COFI closely resembles “advice” under the FAIS Act, and it also allows any institutional form (natural or juristic person), but this is subject to the qualification that it may be amended as part of the separate review process called “the “retail distribution review” (“RDR”) process.
The RDR is a component of the twin peaks financial regulatory regime overhaul and has been developed in tandem with all of the other regulatory changes. It is focused on regulating the distribution of financial products and in particular the activities of asset managers and financial advisors. It has received significant industry pushback and amendment but the outcome of the RDR recommendations have begun to filter through into regulatory amendments. This leaves a fair amount of uncertainty for those currently operating with juristic representatives’ arrangements.
It is therefore critical that any FSP that has a juristic representative review its current arrangements and make amendments before the implementation of COFI. The COFI Bill has been through two drafts for public comment and may be effective in the next year or two. The COFI Bill confirms that juristic representatives for discretionary investment management activities (category II or IIA under FAIS) will no longer be permitted. It is also possible that “advice” activities (category I “advice” under FAIS) will no longer permit juristic representatives.