Twin Peaks: South Africa adopts Australia’s approach

by Dr. Andy Schmulow

The adoption of ‘Twin Peaks’ in South Africa is arguably the most important raft of financial system reforms since the Union left the Gold Standard in 1932. Originally proposed by an Englishman, Michael Taylor, this system was first adopted by Australia in 1998. It consists (in Australia) of the Reserve Bank of Australia (RBA) – the lender of last resort, the Australian Prudential Regulation Authority (APRA) – the guardian of financial system stability, and the Australian Securities and Investment Commission (ASIC) – the market conduct and consumer protection agency.

‘Twin Peaks’ is currently in vogue internationally, and is regarded as the most effective of the four methods of maintaining financial system stability. South Africa is in the process of adopting ‘Twin Peaks’, having based the legislation closely on the Australian model.

There is no doubt that ‘Twin Peaks’ is the optimal system, and this is widely acknowledged. Part of the reason for this was the extent to which Australia was able to insulate itself from the ravages of the Global Financial Crisis (GFC).

However, the system performed poorly during the same period in the Netherlands, where three of the biggest Dutch banks required rescuing. In Australia, ASIC was recently excoriated by the Federal Senate’s inquiry into the manner in which ASIC failed to combat the market misconduct and consumer abuse that was rife in the financial planning divisions of the Commonwealth Bank and Macquarie Bank. It should be remembered that it was market misconduct and consumer abuse that give rise to the Subprime Disaster in the United States, which then metastasized into the GFC. So while ‘Twin Peaks’ is an excellent start, it is by no means the full solution.

Other factors play as important a role. These include institutional capacity and willingness to enforce regulations. These are in turn a function of the degree by which the legislative process is insulated from industry pressure (as is not the case in the United States). As importantly, it includes the extent to which the system stability regulator is insulated from political and industry pressure, as was not the case in the United Kingdom under the now dissolved Financial Services Authority (FSA). The Bank of England (BoE) and the FSA tried to give respectability to their pandering to the banking industry, naming it the ‘light touch’. That ‘light touch’, and the ‘jaw-dropping incompetence and chaos’ with which the BoE and the FSA operated, was blamed by the subsequent Parliamentary Inquiry as the root cause of the collapse of Northern Rock, Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBOS).

Furthermore, the regulator should enjoy a high degree of independence. In Australia, APRA is fully independent of the RBA. In South Africa the Prudential Authority (PA) will be a division of the SARB, and this sub-optimal.

In addition to adopting the ‘Twin Peaks’ model, South Africa should ensure that the PA is well-resourced, adequately staffed and funded, and staffed by motivated personnel who work within an environment that promotes fearlessness. To this end, the legislator should fully indemnify the PA and its staff in the event that they take steps against a financial institution. The PA should have, enshrined in legislation, extensive powers to regulate and to prohibit misconduct. Behind that must be an independent and uncorrupted judiciary, and effective prosecutors.

Finally, because the causes of each financial crisis are new and different, and because they occur so often (Krugman asserts there’s one every 18 months somewhere in the world) the PA must inculcate a culture within the organization that encourages dissenting viewpoints, and that encourages staff to challenge prevailing orthodoxies. That goes to the essence of the most difficult part of the regulators job: the capacity to foresee the unforeseeable.

If all of those factors are present, then South Africa stands the best chance of avoiding, and if not avoiding, then at least mitigating the worst effects of the next significant financial crisis. In this, ‘Twin Peaks’ is merely a good start. To paraphrase Sir Winston Churchill, “Twin Peaks is not the beginning of the end. It is merely the end of the beginning.”

Adv Dr Andy Schmulow
is an Advocate of the High Court of South Africa, the Principal of Clarity Prudential Regulatory Consulting, Pty Ltd, a Senior Research Associate in the School of Law, University of Melbourne, and a Visiting Researcher in the Oliver Schreiner School of Law, University of the Witwatersrand. He served as a Senior Analyst at APRA, and made extensive recommendations to the National Treasury on the Financial Sector Regulation Bill. He provides advice to the Shadow Treasurer, DA MP Dr Dion George.