Financial Intelligence Centre Act schedule amendments: NCRF submission & response

Meeting report

Opening remarks
The Chairperson welcomed National Treasury and civil society groups. The meeting was supposed to be held after the NCOP sitting, but the programme was changed the day before. He apologised to the civil society groups for the last-minute change to the schedule. He asked that National Treasury should also respond to submissions that were made online.

National Clothing Retail Federation of South Africa (NCRF) submission
Mr Michael Lawrence, NCRF Executive Director the NCRF delegation which included industry members from Woolworths, The Foschini Group (TFG), Mr Price Group, Truworths, Pick n Pay Clothing, Cotton On Group, Queenspark, Cape Union Mart a team of attorneys from Bowmans.

The NCRF comment about the Item 11(a) draft amendment to Schedule 1 of FICA was that one size did not fit all. It was concerned that consumers and potential consumers who were developing as credit seeking consumers were going to be prejudiced.

Ms Karon Layton McCann, Bowmans attorney, said the amendment to item 11(a) of Schedule 1 of FICA proposed an inclusion of credit providers as defined in the National Credit Act as accountable institutions.

NCRF had previously made a submission to the Standing Committee on Finance of the National Assembly on the proposed change. The amendment was based on a Financial Action Task Force (FATF) Standard, which required that the ‘act of lending’ is included in the scope of a country’s measures against Money Laundering and Terrorist Financing (MLTF).

NCRF formally objected to the blanket inclusion of credit providers in Item 11(a) considering the drastic and materially adverse unintended consequences that inclusion would have on both credit retailers and retail credit consumers.

It suggested that retailers be excluded by the addition of the following italicised wording in item 11(a) of Schedule 1: “A person who carries on the business of a credit provider as defined in the National Credit Act, 2005 (Act 34 of 2005), excluding credit providers who offer credit as provided for in section 8(1)(a) read with section 8(3) in circumstances where the credit facility in question constitutes a closed-loop, revolving credit store card where a limit is available to the consumer and an instalment is payable monthly.

Alternatively, given that the costs of compliance would be immense, before the change was finalised, the NCRF proposed that an independent risk assessment be conducted on retail credit to determine its level of risk for money laundering and terrorist financing and its inclusion/exclusion from Schedule 1.

If the Committee was unwilling to consider this revision, the NCRF asked the Committee to consider setting monetary limits to exclude low value credit facilities and transactions. In the alternative, the Committee should consider if the Minister should apply his powers to grant an exemption to certain parties from the provisions of the Act.

Ms Jane Fischer, NCRF representative, explained the practical implications of implementing the current Draft Item 11(a). The aim of improving the transparency of the financial system to combat financial crime and terrorist financing was praiseworthy, but the proposed inclusion of all credit providers (who were not automatically financial institutions such as banks) would not necessarily assist with this aim, given that retailers’ businesses and transactions differed greatly from those of financial institutions.

It was highly unlikely that a customer would purchase retail merchandise (such as clothing) to launder money or participate in the financing of terrorist activities. In the view of the NCRF, the risk of money laundering through customer accounts with clothing retailers appeared extremely low because the accounts had small balances and were subject to credit checks. In addition, such retailers did not accept deposits from customers that would give rise to accounts with credit balances. Further such retailers already had in place processes to report suspicious or unusual transactions to the Financial Intelligence Centre.

The practical reality was that 30% to 40% of consumers seeking retail credit would simply not be able to produce or provide proof of residence as required by FICA-imposed customer due diligence (CDD), which would translate into the immediate exclusion of between 3.399 million and 4.532 million South African consumers from the credit market, because they would not be able to provide proof of residence.

Draft Item 11(a) of Schedule 1 of FICA was a barrier for entry into the credit market, was at odds with the stated aims and purposes of the NCA, and was contrary to National Treasury’s own goals for financial inclusion.

Mr James McKinnell, Bowmans attorney, presented a potential constitutional issue that would arise if the amendment was accepted in its current form. Their Senior Counsel advised that the situation would result in a constitutional case against National Treasury because discriminating against a section of the population that represented the less privileged and many previously disadvantaged persons in an unfair manner fell afoul of section 14(2) and (3) of the Promotion of Equality and Prevention of Unfair Discrimination Act. It would also contravene section 9(3) of the Constitution in that it discriminated based on race, even though that would not have been the intention, but it would be the unintended result.

Ms McCann noted that the Financial Intelligence Centre did not conduct a sector study for the inclusion of credit providers as accountable institutions, which if correct, would be surprising and irrational. The nature of the business conducted by the NCRF and its members in the form of retail store credit translated into low MLTF risk.

The practical implications of Draft Item 11(a) for NCA-defined credit providers and retail credit customers alike were far-reaching, undesirable, unnecessary, and drastic. It appeared that the implications had not been adequately considered and were not proportional with the level of risk associated with the business of NCRF members.

Discussion
Mr D Ryder (DA) said that he had a large degree of sympathy for clothing retailers that provided finance, as it was often a step up for people at the bottom end of the market. He recalled that when he got his first job many years ago, he could not afford to buy a suit, so he opened an account with Edgars. Therefore he understood how Draft Item 11(a) would prevent disadvantaged people from accessing credit.

Mr Ryder said there were other sectors within the retail market which were abusive and a differentiated approach would be important. He wondered if a way of achieving that would be to tie some of the compliance issues around store card limits as well as turnover through the accounts. One of the FATF primary measurements was to assess risks and apply risk-based approaches which would be relevant in this situation. Putting limits on the size of transactions would help with tracking turnover through the accounts because if someone maxed out their accounts buying stuff only to settle the accounts by the following month, that would raise a red flag and cause concern for heightened due diligence on the customer.

Retrospective application in terms of ‘know your customer’ would be a very costly, tedious, time-consuming, and labour intensive process. Retail stores would not have the structures in place to set up a FICA compliant structure like the banks had done. He wanted to know if this type of financing fell under the Designated Non-Financial Business and Professions (DNFBP).

Mr Ryder sked if there would be a court challenge pertaining to compliance with the FATF requirements. His contention was that in trying to comply with FATF requirements, it appeared that Parliament had gone with a law that attempted to cover everything to over-comply without having thought about the knock-on effects to achieve compliance. It would take the retail clothing segment of the market several years to reach any acceptable level of compliance. If Parliament continued to produce regulations that set up South Africa for failure, the country risked being on the grey list for a longer time, so the proposed wording from the NCRF was reasonable.

The Chairperson asked how National Treasury responded to the NCRF submission before this was brought to Parliament and also what was the response by the Standing Committee on Finance. He asked if FIC always conducted sector studies. He asked what the FATF required and if it required people living in informal settlements to provide proof of residence. As far as he understood, a greater percentage of the voting population in South Africa could provide proof of residence due to a Constitutional Court decision.

He asked National Treasury to reply to the potential constitutional issue raised by the NCRF and asked if it would want to take a chance with the issue. Government, Parliament and National Treasury were concerned that businesses provided credit far too freely and then people became worse-off in the long term. Parliament was cautious as people often claimed in submissions that if certain laws were implemented, the courts would rule against them, which most times did not happen. People tend to use constitutionality or unconstitutionality of a Bill as a threat to Parliament. He asked the Legal Advisor to advise if he thought this would be a substantive challenge that should be taken seriously.

On the one hand, Parliament would not want to be delayed by a constitutional decision against the Draft Amendment. On the other hand, it would not want to pause the Draft Amendment because of the fear of it being taken to court. He would want to hear the opinions of its legal advisors and researchers. He asked if it would "collapse" South Africa if this part of the Schedule amendments was found to be unconstitutional. He was convinced that if this part of the amendments was to be found unconstitutional, it would lead the FATF to conclude that the Draft Amendment did not meet its requirements.

The Committee had consistently held the view that the poor should not be marginalised and excluded by policy decisions, regulations or legislation passed in Parliament. But it was also clear that the poor and low income earners had also borne the consequences of those who sought to secure profits from them. It often found that the private sector, in search of its own material self-interests (profits), always used the poor as an example of who would suffer the most.

He asked National Treasury to respond also to the Vodacom submission on the Draft Amendment.

Ms D Mahlangu (ANC, Mpumalanga) said some retail stores were abusing the FATF requirements. More time was needed to understand the proposed amendment and how it would impact or benefit disadvantaged groups and people from poor backgrounds.

NCRF response
Mr Lawrence replied that the conversation had been ongoing for many years and NCRF had repeatedly notified Treasury of their concerns in several workshops and through written submissions. Although they understood the NCOP’s limited purview on the matter, they took it seriously enough to reemphasise the points that they had made at every opportunity they had. The NCRF had no record of reply from National Treasury on their repeated submissions.

Ms McCann said the NCRF did a study which they presented to Parliament to demonstrate how important retail credit was to consumers and they showed in court how 40% of consumers started with retail credit, which was a kind of education for consumers to learn how to use credit responsibly and keep it small. The retail stores were not making any profit from the credit on their merchandise, so if customers did not pay them back, they would lose twice as they would lose on the credit and on the merchandise.

Their study also showed that when consumers started with retail credit instead of a different form of credit, they were eight times more likely to get a home loan, which was the reason they believed they were a vital part of the consumer journey to making credit affordable.

Mr Gary van Rooyen, an NRCF representative, said the NRCF supported what the Draft Amendments were trying to achieve and they monitored suspicious transactions and were willing to put in any additional traps to catch the few transactions they were reporting. There were under 10 transactions that were reported to be suspicious in the last year. That could be expanded to a far more appropriate mechanism.

Mr Lawrence said if no one believed the NCRF about the impact of Draft Item 11(a) on the poor, there was provision in the process of drafting legislation for a socio economic impact assessment to be done. They had presented a specific area of concern which they believed was likely to have a substantive economic impact on a struggling group of consumers.

Legal Advisor response
Mr Frank Jenkins, Senior Parliamentary Legal Advisor, replied that the regulations or amendments to the FICA schedules could not be amended by either House of Parliament, but it was a question of approving or disapproving them, as they were submitted to Parliament for approval within a certain time. Parliament was not empowered by the Act to make amendments to the schedules, so it would have to be referred back to National Treasury to take it further.

On the constitutionality of Draft Item 11(a), section 9 rights (equality clause) or section 10 (human dignity) could be limited only in terms of section 36 of the Constitution, which envisaged a balancing exercise. If there had been continued engagement on this item, National Treasury must have already formed a view on this point.

The Chairperson said a lot of work needed to be done on the issue independently of Treasury’s response because the Committee’s reports must exercise more effective oversight. He asked the Committee Support Staff to help the Committee understand the issues and come to an independent view from the Executive. Treasury received the submissions late so it would be unfair of the Committee to expect it to respond to the submissions fully. At the end of the meeting, the Committee would decide whether to meet again this week to hear responses on this.

National Treasury and Financial Intelligence Centre (FIC) response
Mr Vukile Davidson, National Treasury Chief Director: Financial Sector Policy, stated that he would highlight some of the big principles that were identified by the submissions which related to three big areas. The first area was the question of financial inclusion and trade-offs. They were aware of the negative effect that unsecure debt has had on the lowest-earning parts of society, which was something that Treasury was working hard to address, as its impacts were severe on families and often could be intergenerational.

Treasury recognised that whenever it had to subscribe to international standards, there was often tenson between domestic implementation and the way the Bills were crafted. When it came to good financial inclusion, Treasury took a leading role at trying to ensure that FATF took into account the impact on poor economies and individuals, including work that Treasury did to ensure that people were not cut off from accessing financial services.

Exclusion did not equal to proportionality, but rather a risk-based approach that took into account the inherent risk of activities being undertaken in a particular sub-sector and applying a proportionate regulatory approach on the sub-sectors. Risks could evolve over time, for example, 20 to 30 years ago, dealing in scrap steel was not a high risk entity, but today it could be acknowledged that it came with risks. Wholesale exclusions of sectors could complicate the understanding of risks.

Mr Davidson demonstrated that the amendments did not represent knee-jerk reactions, but careful consideration through engagement over multiple years. The consultation process commenced in March 2017 and consultations with the relevant sectors and supervisory bodies continued until 2019. Treasury published the proposed amendments to the Schedules on 19 June 2020 with a closing date of 18 August 2020. The comments received were incorporated where relevant.

At the end of March 2022, the Minister of Finance approved the FICA Schedule amendments be tabled in Parliament. The amendments were tabled on 17 May 2022 and the Standing Committee on Finance held a public comments process on the schedules. The comments received on the FICA Schedules in the Standing Committee on Finance consultation process broadly included entities suggesting proposed wording on certain items, requesting exclusions of their business sectors, and requesting clarity on certain aspects of the drafting.

All but one of the concerns expressed were raised and considered during the Minister’s 2020 consultation process and were covered in the table of comments and responses in that process. National Treasury and the FIC gave a response on the comments received on the 24 August 2022 to the Standing Committee on Finance.

Mr Kamla Govender, Financial Intelligence Centre Senior Legal Advisor, presented on the substantive matters raised by the NCRF as an initial response. He said that the same comments were received during the consultation process in the Standing Committee on Finance, however some new drafting was suggested for excluding retail store card credit facilities.

The old suggestion by NCRF for the exclusion of credit providers was considered when the Minister published the proposed amendments for consultation in June 2020. The NCRF proposed wording was to exclude credit providers that offered credit in terms of a credit facility; and to exclude certain credit transactions. Alternatively, it proposed that an independent risk assessment needed to be conducted on retail credit to determine the level of risk for money laundering or terrorist financing and, therefore, its inclusion or exclusion from Schedule 1.

The Treasury/FIC response was that the application of a risk-based approach required by FICA allowed for businesses to manage their own risks. The FATF required the inclusion of ‘lending’ businesses in the scope of a country’s measures against money laundering and terrorist financing. The standards included consumer credit and financing of commercial transactions and envisaged no exclusions for credit in particular economic sectors.

During the Minister’s 2020 consultation process, the idea of the exclusion of certain credit providers as requested by the NCRF was tested. However, commentators argued that they did not support the exclusion of credit facility providers. Credit facilities contained various types of credit, such as store cards, credit cards, and overdraft facilities. NCRF confirmed that such an exclusion would exclude any credit provider that offered credit cards, including the so-called store cards, overdraft facilities, and revolving credit agreements.

Mr Govender detailed the NCRF and Vodacom submissions and the responses to these, as well as well covering the topics of registration, guidance and awareness, supervision and monitoring of new sectors on a risk-based supervisory approach.

The Constitutional Court challenge would not come in a vacuum because when laws / regulations / amendments were passed, the Constitutional Court would not entertain hypothetical questions. There would have to be an application of the regulation / law / amendment in a particular form, and the defence against that from the affected party would be that the law in itself was constitutionally invalid and should not be enforced.

In the case of Draft Item 11(a), a supervisor would have to impose an administrative sanction for non-compliance against an institution, and the institution would challenge the constitutionality of the FIC and the requirement to apply the FIC Act requirements to the type of institutions on the constitutional basis for the matter to go to the Constitutional Court for consideration. In the absence of a reason for the Constitutional Court to consider the question, it was not likely that it would arise in the context of the amendments or to bring the amendments into force.

Botswana was placed in a difficult position when the FATF considered that the country’s measures for dealing with money laundering and terrorist financing were not in line with its standards and the country was grey listed. The impact of that was that the European Union (EU) declared Botswana as a high risk jurisdiction and all banks in the EU had to apply very strict measures for dealing with banks in Botswana, including the South African subsidiaries that operated in Botswana. That was the reason for the urgency in Botswana to ensure that it was able to address the actions that were required of the country to be removed from the grey list and subsequently removed from the list of high-risk jurisdictions by the EU.

The Chairperson suggested NCRF respond to National Treasury because he had thought NCRF had a very good case until he heard the response from National Treasury and FIC, who also had a credible case.

Mr Ryder agreed and said more research was needed for the Committee to know what action to take next.

NCRF response
Mr Lawrence said that Treasury’s response indicated that the NCRF had made repeated attempts to engage on the matter and several times where Treasury quoted slightly outdated NCRF submissions instead of the updated submission. He asked for a copy of Treasury's presentation

The Chairperson said the Committee Secretary would send it to them immediately.

Ms Fischer said they would provide a specific submission once Treasury's presentation had had received. It appeared that the wording referred to in Treasury's presentation was the initial wording submitted by NCRF to its 12 August submission to the National Assembly Portfolio Committee rather than the current wording submitted to the NCOP, which was a lot more refined and only took account of store credit in a closed group environment. The previous submission proposed to exclude credit facilities and credit transactions as a whole, whereas the current proposition was a match to the limited scope.

The Chairperson said Treasury must reply specifically to the current NCRF proposition in the next meeting and allowed Ms Fischer to continue.

Ms Fischer said they were fully cognisant that FIC applied a risk-based approach and that strictly speaking, proof of residence might not necessarily be a requirement of law. However, the NCRF experience was that in practice it was still something that was looked at in investigations and enforcement matters. Ultimately, all the questions raised pointed to the fact that no MLTA risk assessment was done for the sector, so the practical implications for both FIC and the parties impacted by the change were not looked at. Instead they were merged to be discussed together.

Mr McKinnell said the NCRF submission was not that the Draft Item would be struck down by the Constitutional Court simply on the terms but rather on the impact it would have on disadvantaged groups and individuals. If the regulation was passed in its current form, there would be an impact and it would be struck down because of its discriminatory impact.

On retrospectivity, they were not suggesting that the Act was retrospective in the sense that it automatically applied as if it had been promulgated years ago. However, the impact in a very short space and time was that everyone on any credit provider’s books would be swept into the net and thereby effectively the regulation would become retrospective.

Mr Lawrence said they had now received the Treasury presentation and it had been circulated among the NCRF team and they committed to reply to it in writing soon. Their substantive position had still not changed because they still felt that Draft Item 11 (a) was a ‘one size fits all’ and the regulatory framework would also become a ‘one size fits all’, as well as the application of the law. Within a short space of time, this will become highly prejudicial to the consumer base identified.

FIC response

Mr Govender replied that FIC had to try and quickly apply its minds to the new proposed wording by NCRF and its concern was that the terminology of 'store cards' and so on were things that were used in practice but not in law. The challenge was that the NCRF were looking at the matter from their own understanding of how it would be applied to their industry, but it was not only restricted to their industry as any type of credit provider could make use of the same business model and provide the same store card in a completely different environment and different risk category. This is what made it difficult for the FIC and Treasury to find the precise ringfencing to exclude something entirely from the scope of the FICA.

Closing remarks
The Chairperson suggested that National Treasury, FIC and the NCRF meet outside of the Committee forum to see if they could reach an agreement on what to do because both sides seemed to have credible arguments – although his first sense was that Treasury had a stronger argument.

He was not clear if the FIC did a sector study or not. From his understanding of Mr Govender’s response, there was no FATF requirement that small credit providers needed to provide proof of residence, but it suggested the use of existing provisions. He asked if Treasury was consulted alongside the Department of Trade, Industry and Competition (DTIC) as well as the National Credit Regulator (NCR) on the matter.

If DTIC was properly consulted and it agreed to what was in Draft Item 11(a), it had authority over the matter. As far as he understood, a clause in legislation could be taken to Court to be challenged on its constitutionality even before it was promulgated.

Mr Lawrence replied that NCRF would be happy to meet with Treasury if an opportunity was available for them to do so and as urgently as necessary.

The Chairperson asked Committee members if they agreed that NCRF, Treasury and FIC should meet within 48 hours and revert back to the Committee with a decision that they agreed upon.

The Committee agreed.

The Chairperson asked if Treasury would be available to meet with the NCRF within 48 hours, and if they did meet the NCRF, they should revert to the Committee with a detailed report specifying where they may have agreed, disagreed or needed advice from other institutions.

Mr Davidson replied that Treasury would be available to meet with the NCRF within 48 hours, and would revert back to the Committee in a detailed report as requested.

The Chairperson said the Committee would have a follow-up meeting with National Treasury, FIC and the NCRF on 23 September. He thanked everyone for their participation.

The meeting was adjourned.