Strate - Regulatory & Supervisory Pyramids

FSB responsibilities

The FSB (which is at the apex of each pyramid) is, inter alia, responsible for supervising and regulating the financial markets other than the function of accepting deposits from the general public. This is achieved by; inter alia, the use of SROs which currently include the JSE, BESA and Strate. A SRO in terms of the SSA means “an exchange or a central securities depository”. Section 5(2) of the SSA stipulates that “the Registrar must perform functions assigned to the Registrar by or under this Act and must supervise compliance with this Act by every regulated person”. The FSB is an independent institution established by statute (Financial Services Board Act, No 97 of 1990) to oversee the South African financial services industry with the exclusion of the function of accepting deposits from the general public. The FSB became operational on 1 April 1991, and is financed by the financial services industry itself by means of levies, with no contribution coming from government. The FSB aims to foster an efficient regulatory framework, which reflects a sound balance between statutory control and self regulation. Principle 7 of the IOSCO Principles states: “SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.” The IOSCO recommendation of oversight is enshrined in the SSA. The oversight by the Registrar is applied to the SRO in a strict, fair and effective way. It is widely accepted that the basic principle of self-regulation could be undermined by too much oversight. Where a SRO is appointed and licensed, there is no direct supervision of its Authorised Users/Participants by the FSB. However, the FSB does supervise compliance with the SSA by every regulated person (s5(2)).

Powers of intervention and inspection

For practical reasons, the regulatory arrangements by the Registrar do not place strong emphasis on formal supervision other than on SROs and Clearing Houses. Compliance by the Authorised Users/Participants with the SSA, Rules and Directives of the relevant SRO, is not directly supervised by the FSB and will be driven mainly by complaints by investors and others, as well as by the application of sanctions for non-compliance with the Rules. The FSB has powers to investigate or conduct an inspection on any matter where it receives a complaint, charge or allegation, or if the FSB has reason to believe that a person who provides securities services is contravening or is failing to comply with any provision of the SSA (s 93(1)). This means that the CSD is not only bound by its own Rules, but must also enforce them. Drastic measures can be taken against the SRO where it fails its duties as an SRO. After an investigation or inspection, the Registrar is authorised to:

-	Apply to court for the winding-up or judicial management of the SRO.
-	Apply to court for the appointment of a curator.
-	Direct the SRO to take any steps to remedy the irregularity.
-	Direct the SRO to prohibit or restrict specific activities of a director or other officers if the Registrar believes that the person is not fit and proper to perform such activities.
-	Refer the matter to the Enforcement Committee.
-	Hand the matter over to the National Director of Public Prosecutions where the contravention or failure is an offence in terms of the SSA (see s 94).

The Registrar has the power to impose penalties in the case of any failure by a SRO to submit to the Registrarany statement, report or other document as required in terms of the SSA (s 95).

Enforcement powers

It is important to understand that the role of the CSD as a SRO is balanced by the fact that it is a “regulated person” in terms of the SSA. The FSB has comprehensive enforcement powers over Strate: The Registrar may refuse to renew the CSD licence (s 50(1)). This sanction is very powerful as Strate realises that the CSD business is its core business. On refusal of the licence, the Registrar may take such steps as are necessary to achieve the objects of the Act (s 2), which steps may include the transfer of the business to another similar SRO or the winding-up of the SRO in terms of s 107 (s 50(3)). This sanction could also be very powerful as a new CSD could be licensed and the existing CSD closed down. The Registrar can also refer a matter to the Enforcement Committee in terms of s 94(e) of the SSA. This Committee acts independently of the Registrar and gives the Registrar more effective enforcement powers.

SARB responsibilities

The SARB performs multiple roles, namely:

The Bank Supervision Department of the SARB is responsible for the regulation and supervision of Banks, especially the prudential supervision thereof. Five of the existing Participants are Banks. As such a co-regulatory environment exists between Strate and the SARB in so far as bank Participants are concerned. A MOU was signed between Strate and the SARB in July 2004. This serves as the agreement by which regulatory / compliance information on relevant prudential issues is shared between SARB and Strate.

SARB is also responsible for the payment and settlement system (SAMOS) operated for the banks in the clearing system.

Exchange responsibilities

JSE
The JSE is responsible to the FSB for the supervision of Authorised Users, including the accounting, trading and custody activities. In turn the Authorised Users use Participants for their settlement activities. Strate has no regulatory or supervisory responsibility for Authorised Users. The JSE and Strate, in their roles as SRO’s, do however have a need to exchange information relevant to their respective regulated entities. A MOU, which was signed on 13 October 2003, recognises the co-regulatory relationship that exists between the JSE and Strate.

BESA
BESA is responsible to the FSB to generally govern, control, manage and regulate the affairs of the Bond Exchange and its Authorised Users and to maintain an orderly market for trading in securities. To the extent that Authorised Users are clients of a Participant and the Strate Rules are binding on clients, a co-regulatory environment exists between Strate and BESA. A MOU was signed between Strate and BESA in October 2004. This serves as the agreement by which regulatory/compliance information pertaining to relevant regulated entities is shared between BESA and Strate.

Strate responsibilities

Since all but one of the Participants are banks, the prudential regulation and supervision of the Bank Participants is performed by SARB. For Bank Participants, Strate’s regulatory scope is confined to functional regulation, i.e. Participant related activities of an accepted entity. The Strate/SARB MOU, mentioned above, serves as the agreement by which information is shared on relevant prudential issues between SARB and Strate. Accordingly, Strate will not duplicate the activities of SARB in this regard. However, the prudential regulation of non-bank Participants (e.g. entities such as Computershare Limited) requires increased involvement by Strate as these entities do not fall within the SARB regulatory net. In respect to the Bonds environment, Strate is the appointed Clearing House (previously UNEXcor). Strate is licensed as a CSD for the maintenance of immobilised and dematerialised securities holdings.

The Regulated Entity

The body of the pyramid depicts the flow of information to and from the various parties with regard to Rules, Directives and legislation. The roles performed by various parties vary with regard to the making and updating and implementation of Rules and Directives and the supervision thereof. These are depicted in the downward direction. The upward direction depicts the flow of information from regulated entities to those involved in the supervision of such entities.

Controlling Body and Committees of the Controlling Body

In respect of Strate, the Controlling Body is responsible for the following five activities:

-	The legislative function.
-	The enforcement function.
-	The gatekeeping function.
-	The policing function.
-	Investigation function.

The Controlling Body has delegated certain functions to the Strate Regulatory and Supervisory Committee to which Strate Supervision has a reporting function. Generally, the Controlling Body is responsible for the performance of the entity. Good corporate governance should be fostered for a number of reasons. A primary need is that poor governance can harm economic performance and ultimately effect financial stability. This is because poor corporate governance structures lead to poor decision-making. Weak processes and ineffective procedures and controls prevent early warning signs appearing and hence highlighting deteriorating conditions within an organisation. Transparency and accountability attracts new business – it gives financial incentive to the investing community. In order to attract and retain large pools of capital from investors, there needs to exist credible and recognisable corporate governance arrangements. Weak corporate governance undermines confidence in a financial system and market as a whole.

Compliance Officer

CSD Rule 8.3.1 requires the appointment of a qualified Compliance Officer by each Participant accepted by Strate. The Strate Compliance Officer’s duty is to ensure compliance with the provisions of the legislation, Rules and Directives and to report breaches to Strate. They must have sufficient support and authority from their organisation to discharge this duty.

Management and Staff

The staff of Strate must have the necessary skills and training strategies to ensure they are able to discharge their responsibilities. Staff of the Supervision division also requires judgment to balance their supervisory responsibility without creating a prescriptive regime. They must act with professionalism and empathy but with an appropriate sense of urgency when needed. With regards to the management and staff of the Participant, adequate levels of training and experience must exist to be able to discharge their responsibilities. In addition, management should embrace values, ethics and relationships with their staff and stakeholders, which promote good corporate governance. The Strate Rules stipulate the eligibility criteria of Participants and include a requirement to have competent and experienced management and staff. On an annual basis the directors of a Participant, in their annual report to Strate Supervision, are required to confirm that their organisation has competent staff. Strate as a SRO does not determine what constitutes “adequate and skilled personnel” – this is a responsibility of the Participant’s management.

Internal and External Audit

Participants should have an effective internal audit function, which has sufficient authority and competence to justify reliance being placed on its work. The program of work should cover the custody function of the Participant at least annually. Reports on their findings should be made available to Strate Supervision. Strate in its role a SRO does not currently mandate the submission of internal audit reports of a Participant. The Rules do however give Strate Supervision the power to call for these reports if required. External audits complement the work of internal audit. By agreement with the South African Institute of Chartered Accountants (“SAICA”), specific audits are carried out which provide assurance to the Supervision division. The scope of these audits and the nature of the reporting requirements have been agreed with Strate Supervision.

The Base of the Pyramid

The bottom line of the pyramid shows entities in the securities industry, whether regulated or not.

Participants

The SSA defines a Participant as “a person that holds in custody and administers securities or an interest in securities and that has been accepted in terms of section 34 by a central securities depository as a participant in that central securities depository.” In terms of the SSA, Strate must supervise compliance with the SSA and Rules by Participants. Participants must comply with Strate’s Rules and Directives and must ensure compliance by their clients. Participants in turn should advise their clients of the latter’s obligations in terms of the Rules. Strate Supervision has developed a supervisory program for the Participants. Enforcement and disciplinary strategies have also been developed if any Participant fails to act in accordance with the Rules and Directives.

Securities Lending and Borrowing (“SLB”)

The SLB industry is unregulated. Accordingly the activities of SLB lending desks do not fall within the ambit of Strate’s regulatory responsibility. However, SLB lending desks in the Equities environment have contractually bound themselves as Business Partners to Strate with respect to the settlement of SLB trades. Compliance with these contractual obligations will be monitored and corrective action taken if necessary. Unlike equities, no formal lending desks (Business Partners) exist in the bond environment.

Nominees

In terms of Section 36 (1)(b) of the SSA:
“A nominee of a participant, or any other nominee who has an account with a participant, must be approved by the central securities depository in terms of depository rules.” Strate is responsible for the approval of Nominees, not for the direct regulation of such entities. Strate has released Directive SAN which details the requirements imposed by Strate for Nominees to operate in the Strate environment.

Transfer Secretaries

The transfer secretarial industry is unregulated. Strate cannot therefore issue a Rule or Directive that imposes duties on a transfer secretary. Transfer secretaries, in so far as they are acting as agent of an Issuer, must also comply with the JSE or BESA listing requirements and Strate Eligibility Requirements.

Issuers

Issuers are regulated by the exchanges to the extent that their listing requirements impose responsibilities on Issuers. A section has been included in the JSE listing requirements, which refers to eligibility to operate in the Strate environment. Strate must ensure compliance therewith before accepting the Issuer’s securities for dematerialisation. The diagrams further depict the co-regulatory environment where MOU’s form the basis of mutual co-operation and sharing of information. It is essential to avoid duplicating or over regulating the market.