From rigid rules to flexible principles: South Africa’s approach to financial innovation

The Financial Sector Conduct Authority’s (FSCA) commissioner, Unathi Kamlana, delivered a wide-ranging public lecture at North-West University on June 26, 2024, addressing South Africa’s approach to striking a balance between fostering innovation in the financial sector and maintaining effective regulatory oversight.

Driving the news

The FSCA boss made it clear that his office recognizes its role in promoting innovation in the financial sector while simultaneously protecting financial consumers and the financial system’s integrity.

• This thinking led to the formation of the Intergovernmental Fintech Working Group (IFWG), which consists of South Africa’s financial sector regulators. IFWG is responsible for promoting innovation by unifying financial regulations in the country.
• The lecture comes at a crucial time as South Africa continues to refine its approach to the burgeoning crypto sector.
• The FSCA has granted 138 crypto asset service provider (CASP) licenses as of June 30, 2024, up from 75 in April.
• In addition, the regulator currently investigating 30 cases of unauthorized crypto-related financial services.

Crypto’s economic impact

The Commissioner acknowledged the economic impact of crypto innovation, citing the creation of new sub-sectors and industries.

“Crypto and blockchain technology have not only created a new asset class but have also driven significant investments in new sectors such as decentralized finance (DeFi) and blockchain infrastructure,” he said.

• “For example, countries which have embraced blockchain technology, such as Switzerland, ... have seen a rise in startup activity and investment, positioning themselves as global leaders in financial innovation.”
• Kamlana said his team’s progressive approach to regulating crypto has a similar effect in South Africa, with over 300 crypto license applications received.
• He, however, also mentioned the Mirror Trading International (MTI) scandal as an example of the risks posed by unregulated crypto schemes, emphasizing the need for robust oversight.

Key quote

• Kamlana stated:

“The future demands that as regulators we should be both proactive and adaptive, continuously evolving our approaches to keep pace with technological advancements. This will involve embracing new regulatory frameworks, leveraging advanced technologies for oversight, and maintaining a flexible mindset to accommodate the rapid changes in the sector.”

Principles and regulation

• Kamlana said the FSCA is now an outcome-focused and principle-based regulator.

“We are also shifting towards an outcomes-focused and principles-based regulatory approach, focusing on ensuring fair treatment of customers rather than prescribing detailed rules.”

• The two concepts (outcomes-focused and principle-based regulation) are interconnected. An academic journal by Julia Black at the London School of Economics and Political Science and Martyn Hopper and Christa Band of Herbert Smith LLP places outcomes-focused regulation as one of the three elements of principles-based regulation.

“Principles-based regulation means moving away from reliance on detailed, prescriptive rules and relying more on high-level, broadly stated rules or Principles to set the standards by which regulated firms must conduct business,” the authors wrote.

• The authors listed broad-based standards in preference to detailed rules, outcomes-based regulation, and increasing senior management responsibility as the three elements of principles-based regulation.
• Broad-based standards give preference to high-level, broadly stated rules over detailed ones. Outcomes-based regulation focuses on achieving desired results for consumers and the financial systems rather than processes. Increasing senior management responsibility aims to hold top executives accountable for regulatory compliance.

Of note: FSCA’s regulation also places significant oversight responsibilities on “key individuals,” which essentially include top executives. In a recent regulatory action publication, the regulator re-emphasized its seriousness about holding key individuals accountable.

• Earlier in 2024, an FSCA official confirmed that some withdrawn crypto license applications were related to the lack of key individuals.

Why It Matters

South Africa’s approach to crypto regulation, outlined by Commissioner Kamlana, represents a thoughtful attempt to promote financial innovation while protecting consumers and maintaining financial stability.

• The strategy is particularly crucial given South Africa’s current status on the FATF’s grey list and the global concerns about crypto-related financial crimes.
• By fostering a regulatory environment that supports responsible innovation, South Africa is positioning itself as a potential leader in African crypto development.
• As South Africa continues to refine its crypto regulatory framework, Kamlana’s insights could be a valuable roadmap for other African nations struggling to provide a supportive crypto regulatory framework.