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INFLUENCE: Special Feature: Financial Services

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Making the most of extended SAM timelines

Since the end of 2012, when it became apparent that the implementation of Solvency II will be delayed past its planned 1 January 2014 date, there have been growing concerns and different views across the South African insurance industry about
how Solvency Assessment and Management (SAM) would be implemented.

Following consultation with the SAM Steering Committee and key stakeholders, the Financial Services Board (FSB) has adjusted the SAM timelines in response to stakeholder comments, which included:

• Uncertainty in key areas of the SAM framework
• Important decisions in various technical areas need to be made to provide more clarity for the third Quantitative Impact Study (SA QIS 3)
• Insufficient time to incorporate the results of the economic impact study
• More clarity on the reporting requirements
• Slow progress with the tax basis.

The effective date for SAM implementation will now be 1 January 2016. The FSB indicated that the main change in dates relates to implementation timelines rather than the SAM development timelines.

One key component of the FSB’s recent SAM update includes more detail on the SAM parallel run, which will now consist of two phases to enable insurers to meet the SAM requirements.

The ‘light’ phase of the parallel run will be conducted in the second half of 2014 and will mainly be based on the QIS templates, with some simplified specifications. The ‘comprehensive’ phase will comprise the completion of a full set of quantitative
reporting templates and a ‘Mock-ORSA’, which both need to be conducted during 2015. SAM will undoubtedly result in significant changes and challenges for insurers, but it should be a regime that results, to a large extent, in better capturing and management of risk, resulting in insurers not holding more capital than they should.

PILLAR I
Challenges and benefits
Insurers that have a clear understanding of the SAM capital requirements will benefit by identifying the risk and value drivers,
as well as higher return activities. This capital calculation is not only about the risk charges for each category of insurance
and investment risk; insurers also have to consider the correlations.
A well-diversified and managed business will, in all likelihood, result in lower capital requirements. There are concerns about the complexity of the standard model, which may not be suitable for all insurers. However, insurers do have the option of applying for an internal or partial internal model to adapt to their specific risk profile.

Going through the process of obtaining approval for an internal or partial model is burdensome in the short term, but there
will potentially be long-term benefits.
For example:
• Embedding risk and capital management in the organisation (through the ‘use test’)
• Better reflecting the specific risk profile and the nature of the business, which may ultimately result in lower regulatory capital requirements.

PILLAR II
Challenges and benefits
The board and management are responsible for ensuring that the business is prudently managed. This will require increased rigour
in decision-making and governance, and a deeper understanding of risks and how these impact the business. The board will
need to take ownership of these issues and demonstrate a clear allocation of roles and responsibilities between them.

Many insurers have a number of processes in place to identify and assess risk and capital, as well as to make decisions based on risk and capital information. Embedding these processes in the organisation, and measuring the outcome and reporting on a continuous basis, remains challenging. The Own Risk and Solvency Assessment (ORSA) requires an insurer to bring this all together to increase transparency and to demonstrate management’s own view of its risk profile and capital needs. Forward-looking information will be needed to assess the sustainability and vulnerability of an insurer’s business model.

Stress testing and sensitivity analysis will form an important part of the way insurers use forward-looking information to assess the risks and threats they face.

Pillar III
Challenges and benefits
The qualitative and quantitative disclosure requirements under SAM will be extensive and are likely to include disclosure on:
• The nature of the insurer’s business, objectives, strategies and performance
• Governance structures and responsibilities of the board and senior management
• Risk profile and risk management approaches for each category of risk
• Valuation bases for assets and liabilities.
Given the significant amount of quantitative information insurers need to report on, they will need to have a comprehensive understanding of the reporting requirements and the impact of collecting and collating information.

One of the main challenges facing insurers will be producing reliable information in the required time frames. To meet these reporting demands, streamlining the reporting process is vital, which includes effective integration and cooperation between finance, risk and actuarial teams.

The need for automation, including more effective technology solutions and increased controls, will be an important consideration.

What should you do?
To make the most of the extended SAM implementation timelines, it is important for South African insurers to heed the lessons learnt in Europe, especially those relating to dealing with uncertainty and changing requirements.

As with any large transformation programme, wrong decisions taken due to uncertain and changing requirements can result in significant overspending.

Key lessons to be learned from European insurers include:
• Prioritise and focus on the areas of certainty that will need to be addressed, regardless of the specific details of the final SAM regulations.
• Plan activities to focus on the biggest existing gaps, taking cognisance of the ‘light’ parallel run in 2014 and the ‘comprehensive’ parallel run in 2015.
• Ensure a view exists of the end state in a post- SAM environment. This will help to develop sustainable actuarial, risk and reporting solutions.
• Decide which parts of the SAM programme can be transferred to ‘business-as-usual’ at an early stage, and involve business resources in ‘cycles of experience’ by taking these resources out of their day-to-day activities for brief periods of time for
parallel run activities.
• Know when the SAM programme will and should end – but have a plan in place to deal with the areas not addressed by the programme in either project or ‘business-as-usual’ mode. The SAM development timelines have not changed significantly; however, insurers still have the opportunity, through the FSB’s SAM structures and industry comments, to influence the debate around the
final SAM requirements.

With the SAM implementation date extended to 2016, it is critical that insurers should not lose momentum in the implementation of their SAM programmes. This is crucial, as insurers are already stretched by a number of issues including resources, processes, complexity, data and technology.

There will be greater demands around meeting deadlines and reporting time frames, given the compulsory SA QIS 3 exercise from October 2013 to March 2014 and the two parallel runs in 2014 and 2015, while simultaneously complying with existing regulatory requirements.
Insurers that have made considerable progress with their SAM programmes will be in a favourable position to meet these demanding requirements and enjoy a smoother transition as part of their ‘business as- usual’ process.

Authors: Pieter Crafford CA(SA) is the Advisory Partner: Financial Services Practice at PwC and Francois Kruger CA(SA) is the Assurance Partner: Financial Services Insurance Practice at PwC.

 

Factors that encourage and hinder saving

What is it that makes a person choose to save? Is it a desire that is inherent in them as a result of their upbringing, or is it something else? Well, according to behavioural economist, Keith Chen, and many like him, it’s that something else. Chen recently proposed an interesting hypothesis: do languages that require a speaker to distinguish between the present and the future result in speakers of those languages taking fewer future-oriented decisions?

He questions whether a habit of speech that disassociates the future from the present can cause people to devalue future
rewards, and lead to them saving relatively less. Some of the languages that Chen describes as “futureless” are German, and other Germanic languages like Afrikaans. Through his research, Chen found that when you control for factors such as family
size, wealth levels and income levels, among others, the language that a person speaks could possibly have a big impact on their savings behaviour. He also says that there’s a possibility that the language of communication reflects deeper issues that drive
savings behaviour.

Chen isn’t the first researcher to try and explain the low levels of savings around the world. Mitchell & Utkus (2003) described human beings as hyperbolic discounters. Individuals have difficulty understanding how much is required for their survival in retirement, because it involves the calculation of long and complex time value of money problems over many decades, which requires assumptions about future interest and inflation rates, among other factors.

If we turn our attention to the experience in South Africa, savings rates are poor, to say the least. According to the South African Reserve Bank, the gross savings rate of South African households stands at 1.7% of GDP, as at 31 March 2013. In addition,
household debt is at a staggering 76% of GDP. While behavioural economists have tried to come up with numerous novel explanations for low savings rates, research conducted by Alexander Forbes has found that there are more immediately obvious differences between people that can affect their savings behaviour.

In a book recently released by Alexander Forbes Financial Services, The Benefits Barometer, the research team looked at the savings behaviour of people in each of the major economic sectors, and the results were surprising. The figure below shows the
average contribution rate towards retirement benefits for each sector.

While the rest of the country is contributing at a rate between 14% and 15% of pensionable salary, the Professional and Business Services sector – those with the highest income and financial literacy levels – are contributing at only 12,8% of pensionable
salary. At the other end of the spectrum, workers in the Fishing, Forestry and Agriculture sector are putting away the highest rate of 16,3%. Some of the factors that were identified as being possible contributors to the savings habits of workers in each economic sector are laid out below.

Age
The age distribution of those in the Professional and Business Services sector shows that around 22% of workers are aged between 25 and 30 years. In the Fishing, Forestry and Agriculture sector, this figure is closer to 13% of the workforce, with the majority
of workers aged between 35 and 40 years.
Younger workers generally struggle to commit to saving for retirement, because they find it difficult to identify with their future self and their future needs when their immediate needs – such as financing a car and a home – are so much more urgent.

Gender
When considering the gender split in each of the sectors, it was found that those sectors comprising mainly male workers had higher savings rates. The only exception is in the Personal Services sector, which is made up of teachers and healthcare workers like nurses, and in which 64% of the workforce are female.

Salary increases
The Benefits Barometer may also suggest why savings rates often don’t increase with age. It was found that the average increase in pensionable salary is lowest in the Professional and Business Services sector where, on average, people of all ages
have experienced increases between 4% p.a. and 6% p.a. in recent times. Increases of this amount have roughly been keeping pace with consumer price inflation, leaving people with very little in the way of real salary increases over time. It can be very difficult for people to find things that they can cut out of their lives to save more, once they have established their consumption at a particular level.

Income level
South Africa is a country that struggles with high levels of poverty and large numbers of low-income earners. Many of these low-income earners are found in rural areas not served by banks and investment houses. Furthermore, there is a lack
of financial literacy among this group as well as the wider South African population. One of the implications of this is a mistrust of these financial institutions.

However, income level doesn’t appear to be a significant factor in explaining low levels of saving. Low-income earners have a very good savings culture as a result of innovative savings solutions like the FUNDISA initiative, and informal savings vehicles like stokvels and rotating savings clubs, in which all members contribute the same amount of money each month, with one of them receiving the accumulated pot each month.

It’s not only the decision to save small amounts of one’s income that can be detrimental, but also the decision to withdraw any accumulated funds. Consider the following diagrams, which show the exit rates from retirement funds within the sectors with the highest and lowest contribution rates towards retirement savings, along with the percentage of the withdrawn benefit that is
preserved.

(Source: Member Watch™ 2012 data set, Alexander Forbes Research and Product Development)

In both these sectors, and the retirement funds industry as a whole, the withdrawal of benefits at younger ages is commonplace, as very few people understand the power of compound interest and the value of amounts that are put away early on.

Withdrawal rates decline with age, increasing slightly again between the ages of 55 and 60 years, when people take their benefits just prior to retirement so that they will not be forced to annuitise. But it’s the second figure that has really got
National Treasury sitting up and taking notice. Leakage of retirement benefits out of the system can have a huge impact on the retirement outcomes of people, and while the preservation of benefits seems to increase with age, preservation rates less than
40% illustrate how necessary Treasury’s reform proposal of mandatory preservation is.

The Benefits Barometer not only looks at the issues faced by workers and employers in each of these sector groupings, but also tries to provide stakeholders with workable solutions. For instance, the lack of desire to save among young employees
can be counteracted by communicating with them using innovative technological solutions, and by making sure that the importance of saving is communicated from day one of their employment.

The Benefits Barometer presents solutions to achieve the ‘trifecta of well-being’; that is, physical, mental and financial well-being. While physical and mental well-being are commonly used terms, the lesser-known financial well-being is the one that
is proving to be the most challenging to achieve. Financial well-being involves having enough income and assets to meet your needs throughout your life, with adequate protection in place to ensure that you can maintain this irrespective of what life throws in
your path.

Whether or not an individual’s language affects their willingness to save, research has shown that factors like gender and salary increases do. Most surprising of all is the fact that despite one’s financial background, saving and ensuring that one is financially healthy throughout one’s life is a difficult thing to accomplish.

Michael Dokakis CA(SA) is Branch Head: Administration Services – Financial Services at Alexander Forbes.

 

Retirement fund investment decisions

The importance of the investment decision for retirement funds has been highlighted by the recent changes made to Regulation 28 of the Pension Funds Act. In terms of these changes, new limits have been determined by which retirement funds may hold investments in different asset classes.

These amendments also require that retirement funds comply on a member level, throughout the reporting
period of a fund. The amendments state that a fund must have an investment policy statement and that this needs to
be reviewed at least annually. An interesting addition is also the reference to nine principles that must be applied by the fund and the board. I would like to highlight the following three principles:

• Promote the education of the board with respect to pension fund investment, governance and other related matters
• Ensure that the fund’s assets are appropriate for its liabilities
• Understand the changing risk profile of the assets of the fund over time, taking into account comprehensive risk analyses, including but not limited to credit, market, liquidity and operational risk, as well as the currency, geographic and sovereign risk of foreign assets. These points need to be considered in the investment decision.

Authoritative publications on retirement funds highlight the importance of the investment decision.
One such publication, Pension Fund Excellence and written by Keith P. Ambachtsheer and D. Don Ezra, deals quite comprehensively with the investment decision and the factors, as well as processes that contribute to reaching excellence for pension (retirement) funds.

In this article, I will focus on certain aspects highlighted by this publication.
The main goal of any retirement fund is to create value for its stakeholders, so that it can deliver the benefits to its members in terms of the respective funds’ rules. Having a clear mission, as set out in the fund’s mission statement, is the starting point in the
creation of wealth and ensuring excellence.
One could argue that an adequate investment policy begins with the mission statement of the fund. A properly written mission statement will enable a fund to meet its objectives, and will also provide clarity to all the stakeholders of the fund.

The authors of the publication referred to above offer the opinion that the asset allocation policy constitutes the most important element of the investment policy. The decision process for selecting the asset allocation policy is broken into five elements:

1) What systems are being modelled?
2) What are our goals and fears?
3) How shall we model the future?
4) How shall we make a decision?
5) What course should be followed until the next decision?

What systems are being modelled?
When retirement funds are modelled, the assets or liabilities or both can form the focus of the modelling.
Assets are traded in markets, which determine the market value, growth and returns. The liabilities of a fund, however, are determined by an actuarial valuation. This is periodically – or, in some instances, annually – performed by a qualified actuary.
Of importance is that the trustees should understand the characteristics and the limitations of the models being used.

What are our goals and fears?
As already mentioned, providing benefits to the members in terms of the fund’s rules remains the most important goal of any retirement fund. This should be done at an acceptable cost, translating into an investment objective of seeking an acceptable
level of return at an accepted level of investment risk.

According to the authors, there are three characteristics of goals and risks. They are:
• There are many goals and fears
• They extend over different periods of time
• They are difficult to specify in advance.
Although these characteristics emphasise the complexity of goals and fears, it remains a constructive exercise to specify and articulate them. This will enhance the investment decision.
How shall we model the future?
The authors make the point that in modelling the future, you are actually making a forecast because you are dealing with the future.
For a forecast to be of value, it needs to have the following three characteristics:
• It should be credible.
• It should reflect your fundamental beliefs.
• It should be consistent with the specification of goals and fears.

How shall we make a decision?
The next stage is to take the output from all the aforementioned processes and decide on the asset allocation policy. It is important not to consider too many asset classes. One should also distinguish between liquid and illiquid asset classes. Liquid assets are normally well researched and are priced according to the information available on them.

For illiquid assets, on the other hand, very little information is normally available and they are seldom traded. This makes any price information on them potentially unreliable, and it becomes difficult to forecast the future price movements.

The output characteristics of a number of asset allocation policies can also be compared as part of this phase.

What course should be followed until the next decision?
Once the asset allocation decision has been implemented, the fund’s asset allocation will be changed by market movements. One option is to ask whether one should rebalance to the selected policy.

This should be considered at the point that it becomes necessary (when the difference between the policy and actual asset allocation becomes too big). The cost of rebalancing should also be considered and minimised, as rebalancing requires a transaction – new cash inflow might be lessened.

Conclusion
This article highlights the importance of the investment decision, as set out with the amendments to Regulation 28 and commented on by authoritative publications in the industry. We also focused specifically on the main elements of the decision process in selecting the asset allocation policy, as this is a key aspect of investment policy.

Sources of information:
1. Pension Fund Excellence by Keith P. Ambachtsheer and D. Don Ezra.
2. Government Gazette (No. 34070), Pension Funds Act, 1956: Amendment of Regulation 28 of the regulations made under section 36.

Author: Stephan P

Pretorius CA(SA) is Director LDP Incorporated, Stellenbosch.

 

Collateral management takes centre stage

The occurrence of the financial crisis highlighted the importance of two key fundamentals – credit risk and liquidity risk. In the overthe- counter (OTC) derivative market, as well as the stock borrow lend (SBL), the default of major market participants was realised and the lack of market transparency identified. The events of the financial crisis have given rise to a series of new regulations being implemented over the last couple of years. South Africa, being part of the G20, is not immune to these regulatory changes, and thus, there is a renewed focus on safeguarding the local banking industry.

Both local and international markets continue to change in response to the above; however, the timing and consistent application of these changes prove to be critical in order to avoid any arbitrage opportunities within the markets.

During 2009, the G20 made its aspirations clear, stating that standardised OTC derivatives would be required to be centrally cleared, and that stricter requirements would be imposed for non-cleared trades. In meeting South Africa’s G20
mandate, our local regulator is faced with a difficult conundrum as consideration is given to the merits of establishing a local CCP (Central Counterparty Clearing), or recognising foreign CCPs, or a combination of both. Basel III provides further
incentives to clear OTC derivatives through CCPs by offering significantly reduced capital requirements, as well as the exclusion of a credit value adjustment (CVA) capital charge.

However, while recognising a foreign CCP may appear to be the most simplistic answer, the increased systemic risk that may arise should world markets rely on a limited number of CCPs must be considered. Furthermore, the focus to centrally clear OTC derivatives has the potential to increase liquidity risk, as the increased margining requirements may place strain on cash, which is
predominantly placed as collateral.

Amendments to Basel have brought forth increased capital holding requirements, reduced leverage and new liquidity requirements. This has driven the need for banks to change the way they do business, as they look to reduce their capital requirements and improve their liquidity.

Increased capital requirements
The general increase in both the quality and quantity of capital has been driven by the introduction of the conservation and countercyclical buffer, as well as increased risk weightings in some asset classes. Ensuring that there is adequate collateral posted against these exposures can reduce the required capital charge.

The margin period of risk is defined as the period of price risk that a collateralised transaction is exposed to, i.e. how long it will take to realise the collateral placed. This is used in the calculation of the exposure at default (EAD) in the determination of the bank’s capital adequacy ratio. Basel III has proposed that this period be increased to 20 days for both OTC and securities financing transactions (previously 10 days for OTC derivatives and five days for securities financing transactions), depending on the liquidity of the collateral.

These increased holding requirements highlight the need to have liquid collateral that can be easily replaced
in times of market stress. The introduction of a CVA risk capital charge requires banks to hold additional capital over and
above the minimum capital ratio, adding further strain to available capital. The CVA calculation is a function of effective exposure, and increased collateral decreases this exposure, thereby reducing this charge.

It is common practice for margining thresholds to be a function of the counter-party’s credit rating.
However, this scenario can act as a self-fulfilling prophecy in the market, as the subsequent margin calls can intensify the counter-party’s financial difficulty through creating a liquidity strain. This was noted during the financial crisis and, as a result, Basel III has precluded the inclusion of additional collateral required as a result of a credit downgrade in calculating the EAD.

New liquidity requirements
During the financial crisis, it was evident that liquidity and funding issues proved to be challenging during periods of stress. Thus, while improving on capital requirements, Basel III has also introduced revised liquidity requirements requiring banks to demonstrate adequate liquidity in the short term. The introduction of the liquidity coverage ratio (LCR) gives rise to greater amounts
of high quality liquid assets (HQLA) being required.

These are assets that can be quickly converted to cash without losing any value and ought to be Central Bank eligible (e.g. cash, government bonds, marketable securities and PSEs). The aim of the LCR is to ensure that banks have enough funding
over a 30-day period (a 365-day period for NSFR) should a sudden shock in the financial system and/ or a run on the banks occur. Prior to the SARB introducing the committed liquidity facility, the Banking Association of South Africa estimated a funding liquidity shortfall of more than R900 billion. As liquidity dries up, strategies to free up cash/HQLA are considered, possibly driving the
move from cash to non-cash collateral OTC-type transactions.

Collateral reform
According to the most recent ISDA Margin survey, just under 80% of the collateral delivered globally is in the form of cash. Given the increased demand for cash and government securities to meet the new Basel III liquidity requirements, alternative forms of
collateral will need to be sought. The financial crisis highlighted the importance of managing credit risk, and the use of collateral
has been considered as an appropriate mitigating factor. The use of collateral is estimated to increase significantly, with a recent IMF Working Paper (WP/13/25) estimating a global under collateralisation of about $3 trillion to $5 trillion.

While there may be a move to non-cash collateral in an attempt to address this gap, this in itself has its own challenges. The use of non-cash collateral may reduce liquidity risk; however, it also gives rise to the banks’ susceptibility to wrong-way risk and
concentration risk.

For many organisations, particularly banks, current collateral management processes are fragmented and inefficient – flagging that these need be revitalised. Regulatory pressures will drive this process as banks explore ways to optimise their current collateral management process, while reducing the operational burden. However, this will not only influence banks, but asset managers and
pension fund administrators too, as they look to reduce their counter-party exposure by requiring more collateral.

With the increase in the volumes of collateral, given some of the regulatory reforms highlighted above, current collateral management processes will need to be enhanced to handle the high volume data that involve intense process management
and multiple business lines. Operational risks may increase if the technology is not appropriate. To obtain a holistic view of collateral and eliminate silos, existing manual collateral management practices will need to be replaced by automated processes through upgraded technology.

This will not only allow an organisation to identify its concentration risk, but also reduce potential capacity problems that may arise from the increased volumes, or a possible market stress.

‘Rehypothecation’, or reuse of collateral, impacts the liquidity management process. This is because it becomes more difficult for as their counter-parties would often have to call back collateral from their own counter-parties, complicating the entire process and increasing systemic risk. The necessity for a bank to be able to track its collateral and ensure that the posting or recall of collateral happens in a timely manner was highlighted during the financial crisis.

diagram: automated process

A clearer view
To ensure that the use of collateral is optimised and appropriately managed, organisations will require a
more automated process. This process will need to facilitate the use and valuation of non-cash collateral, track collateral,
calculate and perform margin calls and provide a holistic view of collateral received and delivered.

Switching to an automated process would need to incorporate the processes shown in the diagram at the bottom of page 32.
The benefits of automating the process
• Real-time valuation of collateral would identify wrong-way risk and asset correlation of noncash collateral. Furthermore, it would provide a mechanism to assess the liquidity of the collateral held, which is of importance in times of market
stress.
• A holistic and transparent view of collateral across parties, geographies and asset classes would allow suitable monitoring of concentration risk. Physical collateral settlements, confirmed through a secure third-party solution, would provide an independent inventory check for daily collateral balances.
• Automated margin calls would reduce the susceptibility to manual error, thus reducing operational risk.
• The use of non-cash collateral may reduce the liquidity impact arising from increased margining requirements as a result of the drive towards central clearing.
• A market integrated management system would allow the tracking of collateral and identify where such collateral has been rehypothecated.
• Real-time margin calls provide the opportunity to reduce settlement risk, as they allow a move to intra-day settlements instead of the standard T + 1 settlement convention.
• Establishing collateral agreements with counterparties will clearly define eligible collateral, margin thresholds, etc., thus clearing up
potential miscommunications. The current changes in the regulatory environment will require organisations to change their
business models to improve the management of risks associated with OTC derivatives and SBL transactions.

An increase in the volume of collateral transactions will further necessitate the optimisation of these processes. As a result, over the next six months we would expect a renewed focus on collateral management and the settlement of collateral from both regulators and market participants.

Author: Ashley Sadie CA(SA) is Senior Manager: Capital Markets at Deloitte.

 

FATCA the road to compliance

The Foreign Account Tax Compliance Act (FATCA) is US legislation designed to counter offshore tax avoidance by US persons through strengthening the information reporting and compliance requirements around US persons who have money invested outside of the country.

These information reporting and compliance requirements need to be undertaken by financial institutions, including banks based outside of the USA.

The final FATCA regulations were released in January 2013, which came as a relief to those South African banks that were grappling with the challenges of FATCA implementation. These final regulations allowed banks to update their understanding of the FATCA requirements and its implications across their organisations.

The announcement by SARS and National Treasury of negotiations with the US Internal Revenue Service (IRS) to enter into an intergovernmental agreement (IGA) will also provide relief for financial institutions in South Africa. The IGA should resolve data privacy restrictions required to achieve compliance, limit the occasions when South African institutions will need to withhold on customers, and assist banks and other financial institutions with simpler, more practical implementation options.

South African banks and, in particular, banks operating across the African continent, face significant challenges in achieving FATCA compliance. Banks and other financial services institutions in South Africa have until 25 October 2013 to register with the IRS to be on the first published list of compliant institutions.

The first FATCA compliance deadline is 1 January 2014. Overall, some financial institutions are well advanced in the process and will be ready for these deadlines, while others are not currently well positioned to meet their obligations.

Lessons learned in approaching FATCA compliance in South Africa

Focus on reducing the problem
Reducing the problem through the analysis and filtering of legal entities, products, customer types, distribution channels and account values, which may be prudently descoped, can enable banks to address their distinct challenges and to identify areas of significant impact across their businesses.

This quickly scopes the problem areas and focuses the resource and budget effort to where it is most necessary.

Select the most optimal design solution
FATCA legislation is complex and comprehensive, as it attempts to counter various potential
approaches to evade taxes. Therefore, understanding the complexities of FATCA and distilling its key implications are crucial in
formulating a well-rounded, easily executable FATCA compliance programme in the limited time available.

Selecting an option for compliance is dependent on the nature of the business and the impact of FATCA on the bank. However, due to compliance time constraints and the number of changes required by banks, the solution design may well require tactical solutions with minimal business impact and investment. This will allow banks to achieve compliance by applying low-cost ‘workarounds’
and process changes. Thereafter, strategic and long-term solutions can be better planned, and phased in, with less disruption to the bank.

Concentrate on ‘must-do’, critical activities for 2014
FATCA has phased timelines, which initially run from 2014 to 2017. By focusing on the ‘must-do’ activities that require compliance before 1 January 2014 – such as appointing a Responsible Officer,
registering with the IRS, and addressing new client on-boarding processes and systems – banks can dedicate the necessary resources more efficiently and effectively to meet immediate deadlines.

Clear ownership is key – both centrally and within the local business units
FATCA is a strategic issue for the business,
requiring significant and widespread change. Typically it starts as a ‘tax issue’, but execution has impacts across IT, AML/KYC, operations, sales, distribution and client relationship management.

It is imperative to get the right stakeholders and support on board to ensure that the operational changes are being coordinated, managed and implemented by the necessary multidisciplinary teams across the organisation. These include business operations, IT, marketing and legal and compliance teams, to name but a few. Early involvement and clear ownership is key from the start.

Understand your bank’s footprint in Africa
Many South African banks have operations in other African countries, and have strategically chosen to make further investments throughout Africa. The degree to which these African countries have exposure to the FATCA regulations needs to be understood. It is best to engage quickly with appropriate stakeholders, to understand how FATCA impacts these African countries and bank foreign subsidiaries to find solutions that enable pragmatic compliance.

Conclusion
Although the FATCA regulations are undoubtedly complex, many South African banks are getting to grips with what these mean for them. Local banks are facing strict compliance timelines with limited budgets, resources, time and expertise available.
This is coupled with having to fulfil multiple other regulatory requirements.

To add to the burden, FATCA has encouraged several countries in the European Union to start engaging in a multilateral effort against tax evasion. The support of “other” countries in the IGA process indicates that some of these countries will follow with their own FATCA equivalent
legislation, in an attempt to increase their tax revenues at a time when economies around the world are under unprecedented pressure.

Evidently, it is in the best interests of banks in South Africa and other countries across Africa to mobilise their compliance activities to adequately address FATCA and its far-reaching obligations.

Authors: Megan Couzyn, BComm (Management), Bachelor of Applied Pshycology is a manager in Advisory and an Ernst & Young FATCA specialist and Eugene Skrynnyk (CIPM, MILE, BComm) is a senior manager at Ernst & Young FATCA specialist

 

Converting your insurance risk premiums into revenue

Traditional insurance is a risk management technique that provides no other benefits beyond that of covering the risks insured. The insurance premium is a cost to the enterprise and an investment, and therefore does not provide any return. On the other hand,
‘captive insurance’ provides the solution for converting the insurance premium into an investment, therefore providing additional
revenue to the enterprise.

A captive insurance is an insurance company formed to insure or reinsure the risks of enterprises that have substantial risk locations and conditions, whether locally or abroad. A captive insurance can operate as a direct insurance company or
it may serve as a reinsurance company.

Captive insurance (captives) traditionally underwrite property/casualty insurance coverage such as general liability,product liability, workers’ compensation, professional liability and director and officer liability. Captive insurance is fully
recognised by the International Association of Insurance Supervisors and is offered in many offshore jurisdictions, including Mauritius.

Captive insurance has long been used by many prominent companies to manage their insurance risks. Captives have become a popular risk-management tool for organisations seeking greater control over managing their insurance needs. Two main
drivers in the formation of captives are risk management and risk financing.

A captive helps an organisation to respond quickly to changes in the commercial insurance market and to determine the most efficient way to finance an identified risk. This could mean a lower cost of coverage than conventional insurance markets. The
organisation could also use a captive to obtain coverage for risks that would otherwise be quite costly, or unattainable, in the commercial insurance markets.

Due to increased corporate governance and the need to seek innovative risk management techniques, more and more companies worldwide are now adopting captive insurance to obtain benefits for their effort. Captive insurance serves as a sophisticated risk carrier and provides the following additional benefits:

• Retention of underwriting profits and investment income that would otherwise go to the commercial market
• Earned investment income on unpaid loss reserves
• Lower overhead costs than a commercial insurer’s, allowing a larger percentage of the premium to meet claims payments
• Accessing the reinsurance market, which operates on a lower cost structure than direct insurers
• Premiums based on a company’s own loss experience, not on industry-wide loss standards
• Improved risk management and understanding the cost of risk. In Mauritius, The Insurance Act 2005 defines the captive insurance business as an insurance business carried on by a corporation in Mauritius whose business is restricted substantially to
risks situated outside Mauritius with affiliated companies.

Applicants for captive insurance licences need to apply for an external insurer license with the Financial Services Commission
(FSC) to carry out captive insurance business.

They are usually companies with a Category 1 Global Business Licence (GBL1) duly licensed by the FSC. Rent-a-captive and cell captives are also permitted. They can be structured either as a captive conventional insurance or a captive Shari’ahcompliant
insurance (Takaful). Full details of all programmes to be underwritten must be submitted to the FSC for approval.

With a GBL1 and an external insurer licence, the captive insurance company must also appoint a licensed management company in Mauritius. Captive insurance can be general insurance business or long-term insurance business, with each type having to maintain unimpaired stated capital as prescribed, and maintain a solvency margin of such value as specified in the solvency rules.

Incidentally, captive insurance from Mauritius also enjoys tax benefits. For taxation purposes, captive insurers are nominally liable for Mauritius income tax at the rate of 15%. However, by being a GBL1 company, a captive insurer can claim credits of up to 80% of the Mauritius income tax payable for taxes incurred and paid in foreign jurisdictions.

The effective tax rate is 3%. There is no capital gains tax and no withholding tax payable in respect of payments of dividends to shareholders in Mauritius. In view of the above cost savings and benefits, the setting up of an insurance captive in Mauritius
is likely to prove a flexible, cost-effective self-insurance vehicle for alternative risk transfer.

Moreover, it provides an efficient way of converting an insurance cost into revenue.

Author: Najmul Hussein Rassool, MBA; Post Grad Dip (Economics); CIFP-Inceif. Product Development Specialist, Cim Global Management Services Ltd Mauritius

Ringing the changes in short-term insurance

Few industries in South Africa are as competitive as short-term insurance. The four main players – Santam, Hollard, Mutual & Federal, and OUTsurance – account for only 40% of the market, with another 28 insurers included in the remaining 60%.

Twenty years ago, if you wanted to buy insurance you would have had to do so via a broker, whereas today less than 50% of new insurance comes from the intermediated channel.

Yet the market offers considerable growth potential – in South Africa alone 60% of cars on the road are uninsured, and this country accounts for 70% of the total African market, suggesting a far greater opportunity north of the border.
This opportunity explains the profusion of new players and channels coming to market: today you can buy insurance not only from your broker, but your bank, your retailer, direct (either by phone or online), through affinity groups such as the likes of Kaizer Chiefs, as well as through cellphone companies (telcosure).

Much of this new business has come from new players, but the traditional players such as Santam and Mutual & Federal have also embraced new channels.

New channels abound
Ian Kirk, CEO of Santam, explains that each of these channels has strengths and weaknesses but that even an insurer such as Santam which regards the traditional broker insurer as its primary channel, needs to support multiple channels.

“In today’s industry, with all the choices and channels, the customer is very definitely king, and there is a closer relationship between the insurer and insured. In the past, the broker controlled the risks of the underwriter, but today it is the insurer who can
select the risks they wish to take on,” says Kirk.

As for the realities of the past year, Hennie Nel, chief financial officer at Santam, explains that insurers are stuck between the figurative rock and a hard place. The Rand plummeted 11% in May alone and 50% over the past two years. He explains that
while retailers can squeeze their suppliers to limit the inflationary impact, insurers have no such power to push back increases: “Try telling one of the major car manufacturers to absorb some of the cost of rand
weakness.

” Yet the price of parts accounts for 80% of the cost of most motor claims, and cheaper parts cannot be sourced or car maintenance plans are voided.

He explains that while direct insurers can increase rates immediately, the intermediated (via brokers) business remains a traditional one in which brokers prefer to adjust premiums just once a year at policy renewal.

Nor has the weather been kind. All insurers suffered from the triple blow of Eastern Cape storms, Gauteng hail devastation and the St Francis fires. Brooks Mparutsa, CFO of Hollard, says: “It’s during such catastrophes that insurers are critical in providing financial certainty, as we protect our customers from such losses.”

Insurers are using risk management technology and techniques wherever possible, but some things are beyond their control. Nel says that municipalities are not always enforcing building regulations, and emergency services leave much to be desired.
“Furthermore, when the economy slows, risk management is often the first casualty by companies and individuals alike. Individuals can reduce or cancel security or tracker services, which results in theft.”

That’s not to say insurers are powerless: Santam, as do others, insist certain vehicles have tracking devices, homes are secured when vacant and take a zero-tolerance to drinking and driving and fraud.

Most insurers have established crime bureaus as well as collaborating in an industry-wide initiative to use advanced analytics and sharing data. Banks have always been indirectly involved in insurance through their massive mortgage books.

Recognising this, as well as the enormous size of their client bases, bancassurance has become one of several insurance trends of the past 20 years. During that time, Standard Bank Insurance Services (SBIS) has evolved from a vanilla home owner insurer to offering the full suite of cover, with its own short-term insurance licence, says SBIS head Denise Shaw.

She says the model of the business is to provide insurance services to existing Standard Bank clients, and its value proposition is that, unlike direct
insurers, it does not have to extensively advertise and is therefore less well known.

“There are a number of triggers to people acquiring our products – for instance, credit life when acquiring a payment card, funeral policies are well embedded in many triggers, and home insurance is mandatory when getting a mortgage bond,” explains Shaw.

Other products are sold through call centres, a policy which will also be under review when the Privacy of Personal Information (POPI) Bill becomes law. The insurance industry is facing a wave of consumer protection-type legislation in order to conform to international standards, and Shaw believes this will stand SBIS in good stead competitively as the bank has already adjusted to
a wave of such legislation in the banking sector.

Concepts such as Treating Customers Fairly (TCF) are well entrenched.

Africa beckons as global insurers have bigger fish to fry
South Africa’s own emerging market, along with the frontier markets of Africa, is becoming the next playing ground for our insurers. Almost all identify this as their major strategy for the coming five years.

Mutual & Federal recently opened branches in each of Botswana and Namibia and has developed relationships with insurers in Zimbabwe and Swaziland. Last year it expanded its Africa team sixfold.

Few insurers have a solid African footprint yet: most are less in expansion mode and more in a learning and research phase for future growth. In the case of Mutual & Federal, Santam and SBIS, each has a parent company with an extensive footprint across Africa, which will enable rapid roll-out once they get into expansion mode.

Insurance penetration in Africa is minimal (less than 1% in Nigeria), but barely worse than it is in rural South Africa (less than 10% in the country as a whole). The positive experience of banking in this market demonstrates that considerable potential exists given innovative solutions aimed at the rapidly expanding middle classes across the continent, as well as commercial lines.

Renee Rautenbach, CFO of Momentum Short-Term Insurance, says: “‘Africa remains a very important market to fast-track the growth of the MMI group (the holding company), which has earmarked R500 million for further investments in the 12 African countries outside South Africa where it already has a presence.”
“Multinational companies are investing heavily into Africa at the moment, and these are companies that require quality insurers in order to meet their own compliance standards, whereas each country has its own regulations which require such companies to have
an indigenous insurance provider – so having a local presence is essential,” she explains.

“More and more countries are looking at their regulatory framework as their economies are maturing – with an emphasis on retaining in-country as much economic activity as possible,” she says.

Nel explains that Santam’s Africa strategy to date has included suppling specialist cover to multinationals undertaking large engineering contracts in Africa, using as a base its presence in 10 countries leveraging off parent Sanlam’s Africa footprint, though it has a direct presence in Namibia and Malawi.
“African countries are individually very small markets, but there is an opportunity for us because the large, international insurers are currently preoccupied with the far larger new markets of Asia. Due to extremely low penetration, the opportunity in Africa
is considerable for the future, and it is at better profit margins than South Africa,” says Nel.

Shaw says that Africa is on the agenda of every South African insurer, and it is the strength of one’s geographic footprint and distribution capability that will dictate success: “However, it is very complex, as each country has its own rules. Therefore, Standard Bank’s extensive footprint and advisory capability is a major advantage.”

“More and more countries are looking at their regulatory framework as their economies are maturing – with an emphasis on retaining in-country as much economic activity as possible”

Plenty of new business potential exists in South Africa’s mass market but it is a difficult market to succeed in.

Much new business exists in South Africa’s mass market
While these insurers are consolidating their Africa teams and strategies, there is plenty to keep them occupied at home, where the market is far from saturated. Kirk emphasises that barely 40% of the cars on our roads are covered, due to the absence of
compulsory cover which is mandated in many other countries.

The mass market remains a focal point, itself a requirement of the Financial Sector Charter, but also due to the growing middle class in South Africa. Technology is a massive enabler of this industry-wide initiative. Hollard’s Mparutsa says one key driver of reaching this market is the almost 100% cellphone penetration in South Africa, even rural areas.

“New and existing clients can be approached via mobile telephony to buy cover, administer policies and even process claims,” he says. Kirk explains that such comprehensive cover is rarely financially viable for the lower income consumer, and benefits have had to be trimmed to make it affordable: “Like the banking industry’s Mzanzi product, our purpose is to sell basic cover such as funeral policies, cellphone insurance and Legal Assist, and then use the client data to try upsell to include motor and home insurance – but this is a long-term objective.”

Technology becomes the enabler
The enabler of this, as well as more efficient pricing of all underwriting–is data analytics, or ‘big data’. Client data is enriched with data from other sources to identify the wattractive risks, says Kirk: “Though this will have to be carefully assessed once POPI [Privacy of Personal Information] becomes law.” Claire Wood, executive of InnoSys, a technology company specialising in the short-term insurance market, says: “Technology plays a major role in the
short-term insurance industry.

Over the past decade, a vast amount of time and money has been invested by insurers into software solutions that support
actuarial underwriting and enforce regulatory compliance. But it’s not all hard numbers and big sticks, technology can be an especially powerful tool in building loyalty to your brand.

“For policyholders and brokers, the ease of interacting with their insurer is key. There is a definite shift in the approach to providing information to customers or business partners: whereas previously the insurer would supply information when and how
they thought fit, today access on-demand is increasingly expected. This spans brokers being able to draw reports against real-time data to social media channels actively manned to address policyholder complaints immediately.

Effortless interactions come from technology which allows the consumer to choose when and how they engage and ensures each engagement is a positive experience,” explains Wood. Kirk adds: “Technology underpins much of our risk management policies – we are able to tap into weather services and warn clients of impending storm and hail threats, and Google Maps can also be used to identify buildings carrying high risks.

Telematics gives insurers comprehensive information about individuals’ driving habits and enables us to more efficiently assess risk and price accordingly,” adds Kirk. Shaw explains that technology is opening up the low end of the market through the saturation of handheld devices: “People can buy all our products without speaking to anyone, and it is this technology which is enabling us to get penetrate rural communities. We’re about to introduce an app whereby clients can do everything online from buying products to registering a claim, similar to online banking.”

The MMI Group obtained 100% shareholding in Momentum Short-Term Insurance in July 2012, and views short-term insurance as an important ingredient of its strategy. Momentum Short-term Insurance was created in January 2006 as a joint venture between
Momentum Group and OUTsurance Holdings.

Rautenbach explains its strategy: “We’re going back to the broker in a very big way, and offering not a product based proposition but a holistic approach that looks at the entire needs of clients, whether short-term or life cover, as well as wellness options. We therefore look at clients with a view to the total optimum solution for them.”

This is because, like SBIS, it comes from a large group and is not well known as an individual entity. “We’re using our expertise and client bases in life insurance and employee benefits to offer them short term policies, while also expanding into commercial
business. For the moment, our primary focus is to successfully exploit opportunities within the MMI Group,” says Rautenbach.

She believes that Momentum also has a potential competitive advantage with new regulations: “Given that we are investing in infrastructure and new systems, we have the opportunity to embed new regulations into our systems and business processes, unlike most other insurers who have to integrate these into their legacy systems and doubtlessly view it is an unwelcome cost,”
says Rautenbach.

New competitors aim to upset the apple cart
One of the most recent entrants to the crowded marketplace is King Price, and demonstrating how there is always space for a new idea, CEO Gideon Galloway says it is expanding twice as fast as most competitors did in their equivalent phases of existence.

He says insurance is over-complicated by participants and that its success is down to price: “Nine out of ten people buy insurance based on price – and we’re the cheapest 71.5% of the time.”

He says that’s precisely why aggregators such as Hippo exist, but he recommends consumers not rely on such aggregators, but rather do the legwork themselves for truly competitive quotes. He sees the same companies presenting multiple brands through
aggregators.
“We’re the cheapest and we reduce policyholders’ premiums every month as the value of their cars depreciate. When insurers do not do this, and in fact inflate premiums every year, the policyholder ends up paying premiums on much more than what his car is actually worth,” says Galloway.

“This doesn’t happen in other countries, where they are required to quote for business each year, while in South Africa we have automatic annual adjustments. That is a serious disadvantage for consumers. Some insurers say they adjust values down, but the question is do they simultaneously adjust premiums down,” he adds.

He describes bonus schemes as another ploy used by insurers to retain clients long past their due date: “If an insurer offers a bonus scheme, they are compelled under regulation to place 7% of their policyholder’s premiums in reserve, and in turn they
lift their premium to account for this. We prefer to simply give the 7% premium to the client as a discount immediately.”

While the major brands claim it is brand confidence – primarily confidence that they will pay claims – which wins clients, Galloway says lesser known brands cannot get away with not paying claims, even in the unlikely event they wanted to: “It is paying claims promptly which ultimately retains clients and what insurance is all about. We pay claims as fast as possible to keep
clients happy, but also crack down on fraudulent claims. “There is a lot of fraud in this industry, and we investigate every suspicious claim, as well as keep assessors and panel beaters honest. We have state-of the- art technology to help us achieve this.”

“Effortless interactions come from technology which allows the consumer to choose when and how they engage and ensures each engagement is a positive experience”

A strong industry assimilates regulation
Professional services firm KPMG, in its review ‘The South African Insurance Industry Survey 2012’, shows that over the past decade, direct marketing and niche players in the short-term insurance market have captured more than 10% of the market (as opposed to new business), from heavyweights such as Mutual & Federal and Santam, but that the established giants still
clearly dominate the industry.

According to the report: “The state of the South African insurance industry is healthy. Locally the industry is mature, but well established and sustainable. Margins are under pressure, but opportunity exists to build a more sustainable and stronger business, capable of managing ongoing regulatory change. Great opportunities exist to expand into fast developing African countries.”
Partner and national head of insurance at KPMG Gerdus Dixon says: “The level of legislative and regulatory change facing both the short-term and life insurance industries would suggest that smaller players might struggle to keep pace with the ongoing
and significant adjustments to the playing field.

The implementation of Solvency Assessment and Management (SAM) is already fuelling speculation of merger and acquisition activity ahead of its expected implementation date in 2016.

“The additional staffing and improvement to IT systems come at a cost that may not be viable for some of these smaller operations,” says Dixon. SAM is only one of a raft of other regulatory changes facing the industry. Also on the cards in the near future is Treating Customers Fairly (TCF), an example of how the regulator plans on continually evolving regulations to manage market conduct and influence the way that insurers conduct business with customers.

“Communication and implementation of regulation by South African authorities has generally been very good, and there is no feeling of massive regulatory uncertainty,” says Dixon. “As a result, the industry has been generally accepting and even supportive of
the direction that regulation and legislation is taking.

There appears to be a shared understanding that the steps being taken are necessary and are moving in the right direction.”
Ongoing regulation, however, might slow down the growing market share of the smaller players, and potentially make them more vulnerable to merger and acquisition activity.

The survey reveals clearly that administrative costs are running well ahead of profitability growth and premium inflation. The increasing administrative costs are likely to be at least partially the result of regulatory changes and suggest that consolidation in an effort to achieve scale might be an industry response.

The likely result is an insurance industry still dominated by very large players, but with an extended product offering, flexibility and direct and alternative distribution channels typically associated with smaller, newer entrants to the market.

“More and more countries are looking at their regulatory framework as their economies are maturing – with an emphasis on retaining in-country as much economic activity as possible’’

Sustainability is the future
A new addition to KPMG’s Insurance Survey in 2012 is a sustainability article, covering the 10 generic sustainability ‘megaforces’, and how these will impact the insurance industry going forward. The report states: “The basic premise of insurance is the ability to
predict and set premiums that cover actual claims and other expenses.

The sustainability of insurers would be called into question should that predictability no longer become possible. Weather events in particular have become increasingly difficult to predict. The survey shows that natural disaster frequency and severity has increased dramatically – a clear trend can be seen.

However, the ability to match the trend to events and reflect it with annual premium adjustments is a far more challenging prospect.
Another sustainability issue is the ability of customers, be they business or consumer, to afford the premiums. The rising cost of goods and services, puts the disposable income of the consumer under pressure and impacts the affordability of insurance products. This calls for innovative product features that respond
to consumers’ changing circumstances.

Claims management
The high incidence of natural disasters and fire claims in 2012, following several years of increasing claim levels has accelerated claims processing, with Mutual & Federal, for instance, reporting as many as 3,000 hail-related claims received during November and December alone.

The KPMG report states: “At the heart of any insurance company is the claims management process. The better the process, the more likely the insurer will be successful in retaining and winning new customers and thereby growing revenue and profits. The South African insurance industry has become increasingly sophisticated in managing its claims process, this includes settling legitimate claims quickly and efficiently, reducing leakage or over paying for claims, stamping out fraudulent claims, preventing duplication of effort by centralising data, providing flexibility within the claims team to manage fluctuations in the number of and type of claims, working within a compliance aware environment, ability to transfer knowledge and excellence in people management.”

Shared services and outsourcing
The 2012 insurance survey predicts that outsourcing and shared services are likely to be features of the insurance industry in the next few years. This is in part driven by the global shareholders embedded within South African insurance companies, as well as
the significant African expansion plans necessitating standardisation and consolidation of functions across broad geographies.

Author: Eamon Ryan, LLB (Hons) is a Business Journalist.

 

The last mile of finance: ‘good’ just isn’t enough

Year-end. For any accounting professional, this signals a frantic and highly pressurised period. Time and tempers are short as finalising the numbers dominates the office. This is the ‘last mile’ of finance, culminating in the release of financial results.

As with any product, quality assurance is necessary to ensure accuracy and integrity. Unfortunately for finance, the assurance that should occur in this last mile is often tainted by a lack of visibility, and manual processes which result in unpredictable, unreliable or
even untrustworthy outcomes.

Year-end is the bane of professional accountants everywhere. It is no secret that the supporting processes are neither foolproof nor smooth. According to a CFO magazine survey, 49% of professionals believe that finance is ‘functioning adequately but not
optimally’.

There has been much technical progress in then past 20 years. In today’s offices many clerical tasks have been eliminated; shared services and outsourcing have streamlined the payroll, accounts and invoicing processes, while consolidation systems have addressed intercompany reconciliations. Analytics is greatly aided by data warehouses and corporate performance
management tools.

However, the last mile remains fraught with frustration and challenges. The earnings release keeps on getting moved forward, and businesses want more exact final numbers earlier in the cycle. As expectations rise, ‘functioning adequately’ is not good
enough for the finance department.

Sprinting into the ‘last mile’
What needs to be done to optimise the last mile of finance and create an efficient production platform for finance? Here are some guidelines:
Establish enforceable global standards: Standard approaches to processes are critical in global companies. A single agreed-upon approach, enabled by technology, creates stronger controls and efficiencies. It also enforces tasks and follow-up, and reporting on
exceptions.

Introduce task management: Technology can deliver the required information at the right time to leave finance team members free to focus on valueadding work. Task management means focusing resources on the valuable and not the inconsequential.

Enable process transparency: Process management tools give finance management early warning of issues, and thus the ability to correct course in mid-process. This level of process agility avoids the frustration of issues that turn up late in the process and cannot be resolved without fear of unpleasant surprises.

Embed controls/compliance: Where possible, embed controls into daily operations and move testing out of the last-mile cycles.
Integrate technologies: The integration of existing technologies across the last mile is where real optimisation can be achieved. The interdependency of last-mile tasks allows for technology to make the links between close tasks, controls and the published
results.
This gives management greater insights into the processes. The reasons for having a well-managed finance operation are obvious, and include efficient use of resources, achieving regulatory compliance, avoiding embarrassing restatements, being acquisition-ready and obtaining needed financing.

Taking a holistic approach to the last mile creates synergies across finance governance that generate insights and efficiencies well beyond a check in the regulatory box. As noted by Gartner analyst Jon Van Decker,
“When considering the automation and unification of critical financial processes, such as account reconciliations, compliance and financial close, the whole is greater than the sum of its parts. These activities are highly dependent on each other and,
when unified, create new insights and return on investment.”

An optimised last mile means more than a reduction in stress levels for the finance team. It also ensures the delivery of predictable and reliable results to the market — with a beneficial long-term impact on the company’s reputation and, ultimately, its share price.

Author: Conrad Steyn, B.Eng Industrial ( Cum Laude); MBA is Director Barnstone Corporate Services.

 

Minimising risk in B-BBEE ESOP schemes

The employee share ownership (ESOP) elements of broad-based black empowerment (B-BBEE) schemes are designed to give large numbers of employees the opportunity to participate in the success they are helping create. Although many companies
introduce ESOPs for purposes of empowerment, some also see them as great opportunities for building a more committed workforce.

A typical scheme would involve an employee trust that holds shares in the company for a certain period. If all goes according to plan, the dividend flow funds the purchase of the shares. Thereafter, employees receive the dividends or a cash windfall when the
shares in the company are sold.

Many schemes have milestones at which employees can decide whether they wish to continue in the scheme or cash out. This decision depends on their assessment of the share’s long-term prospects and their personal financial circumstances at the time.

ESOP beneficiaries are likely to include manual and blue-collar workers who can be put off by this complexity as well as unfamiliar financial concepts. For most, English is not a first language, and they are often difficult to reach because they work in remote
areas, frequently in shifts.

Success depends on following the right processes
In short, these milestones can turn what should be loyalty-building into a negative exercise that can even provoke labour action. At Barnstone, we have helped several clients successfully negotiate these and other pitfalls.

Clear success factors that have emerged are:
Inclusive communication with all stakeholders is vital. This is probably the single most important factor.
Playing open cards with the unions from day one is vital, as is involving them in the process. In fact, for one mining client, we got the union to convene the meetings with each group of miners and – certainly for initial meetings – both union and management
representatives joined the Barnstone facilitator.

Communication must be consistent and accurate. These schemes can be complex and explaining the deal structure, the workings of the stock market and the element of risk can be extremely challenging – but has to be done to avoid possible future problems when
milestones occur.

Planning must be both detailed and flexible. More often than not deadlines are tight and large numbers of people must be consulted. At the same time, though, plans can go awry, so you have to build flexibility into the planning and scheduling. One key benefit we offer to our clients is experienced and mature programme management.

Facilitators must have the right profile. Using the right facilitators is another important success factor. Appropriate language skills are compulsory, but as facilitators are in the front line, they must be cool-headed under pressure and able to stand their ground. At all times they need to project the correct professional and corporate image to be seen as both expert and trustworthy.

Giving facilitators the right kind of training to deal with all eventualities is a must. External facilitators can play a critical role. There
is often a level of mistrust between management and worker, and many managers resist facing up directly to employees, especially given the tensions that characterise annual wage negotiations in South Africa. Outside consultants can more easily establish
themselves as neutral participants.

This entails staying out of company politics and past disagreements. Using external facilitation offers ways around the
challenges in such schemes. This helps ensure that these go beyond ticking the empowerment box and can deliver the long-term benefits of a more productive workforce.

Author: Werner Botha is a Consultant at Barnstone Corporate Services.