C H A P T E R 2
Impediments to NBFI Development and Policy
Reform Agenda
As in the case of SEC, NBFIR management faces major problems to attract and retain pro-fessional staff because it is not allowed to charge fees and to use the proceed of these fees to pay competitive salaries.
Market participants identify the following problems in financial regulations as major impediments to financial market development in general and NBFI sector in particular:
■ Regulators lack adequate political (legal and institutional) independence. There is continuous political intervention (from the Government, Parliament and often powerful financial institutions) into the decision making process of the financial regulators. Appointment of senior management is compromised and is often dri-ven by the political favoritism rather than recognition of the competences and impeccable reputation of the appointees.
■ Regulators face serious problems of underfunding. Small wages (NBFIR pays less than 50 percent of what NBU pays to its staff and less than 20 percent of the mar-ket remuneration levels) distracts professional staff and results and high rotation of personnel.
■ Existing technological support of regulators (IT/MIS, other equipment) does not allow timely collection and analysis of data (even mandatory regulatory reports) thus defusing the quality and timeliness of the regulatory analysis and corrective actions.
■ Poor enforcement capacity of regulators results in low transparency, poor corpo-rate governance and non-level playing field in the market, etc.
■ Confidence in the financial market is still relatively fragile, especially in the area of NBFIs. Investors working in the NBFI and capital markets would appreciate sta-bility, transparency and predictability in the actions of the regulators as well as legal framework.
The program of the Government of Ukraine submitted for Parliament’s review in February 2005 envisaged the merger of SEC and NBFIR. However, there has been no further pro-fessional discussion in this regard. Moreover, the local financial markets community has seriously questioned the timeliness and the rationale for such a merger, provided that no in-depth review of the existing problems has been made. The market also has a significant concern regarding the commitment, willingness and ability of the Government of Ukraine to address the existing legal (such as independence and enforcement capacity) and insti-tutional deficiencies (low funding, poor skills and motivation of the personnel, inade-quate IT/MIS support) in the activities of the NBFIR and SEC that are imperative for successful institutional reform of the regulators and future market development. Inter-national experience shows that merging regulators is always a difficult undertaking. For example, it took more than five years to complete the merger of activities of separate reg-ulators into the new Financial Services Authority (FSA) in the United Kingdom. The exist-ing institutional weaknesses of both SEC and NBFIR and the lack of political consensus on the objectives and the outcomes of the reform will make this into a formidable challenge in Ukraine.
Should Ukraine move towards integration of the regulators, successful implementa-tion of this process would require the following key priority acimplementa-tions:
48 World Bank Working Paper
■ Establish a Task Force to advise on the nature and the timing of the merger includ-ing a number of highly reputable international and local experts from the financial regulators (NBU, SEC, NBFIR), the Ministry of Finance, Ministry of Economy, the Anti-Monopoly Committee, and selected representatives from the private financial sector or their professional organizations (banking community, securities market and NBFI market).
■ To instruct the Task Force to discuss and design a strategy of merger of two regu-lators that will include such details as: (i) objectives; (ii) phasing; (iii) reform man-agement mechanism (special Transition Manman-agement Committee similar to UK or Hungary); (iv) legislative and institutional changes required to implement the reform and ensure proper independence and accountability of the regulator;
(v) benchmarks allowing the assess the success or failures of the reform as well as iden-tify existing or potential weaknesses in the performance of the integrated regulator;
(vi) cost plan for the implementation of the reform; and (vii) HR/staffing plan (which will include the proposed strategy for redeployment of staff, severance pay-ments etc). The Task Force should be given 3 to 5 months to accomplish this task.
■ To present the proposed strategy to the professional constituency as well as Gov-ernment for discussion and finalization. The transition timetable should reflect realistic assessment of the strengths and weaknesses of the financial regulators, human resource limitations, knowledge gaps and absorption capacity of the exist-ing or new staff of the regulators. Moreover, the transition should ensure smooth transfer (merger) of functions without undermining the actual quality of supervi-sion and compromising the interests of the market.
■ To appoint a Transition Management Committee or a specially authorized Coor-dinator of the reform. At the same time, both regulatory agencies (NBFIR and SEC) should continue to perform its statutory regulatory and supervision functions to prevent unnecessary market disruptions and mitigate the risks associated with pos-sible increasing uncertainties about the course and results of the reform.
■ To deploy international expertise, as required, to provide professional consulta-tions and guidance on the course and substance of the reform before action plans and timetable is adopted.
■ To ensure that the top management of the regulatory agencies and champions of the reform have undisputable professional reputation and have no conflict of interest which might discredit the value of the reform in the financial sector.
Regardless of the decision on the merger of the regulators, the following reform measures would need to be undertaken as a matter of priority:
■ To reform the funding mechanism for the new regulator, allowing it to collect fees from market participants.
■ To allow the new regulator to set salaries outside the civil service salary scale and at levels that allow it to attract and retain the senior market expertise that it will require.
■ To tighten the registration and licensing/relicensing process for capital market intermediaries and NBFIs, in particular by increasing the power and the capacity The Development of Non-bank Financial Institutions in Ukraine 49
of the new regulator to trace the ultimate beneficial owners of capital market inter-mediaries and NBFIs, to carry out background checks on these owners, and to carry out fit and proper tests for controlling shareholders and managers of capital mar-ket intermediaries and NBFIs.
■ All these measures are critical to ensure the integrity of the regulation and super-vision of the market. The last measure can play a critical role in streamlining cap-ital markets and in reducing the number and fragmentation of the institutions operating on the market.
Over the longer term, as part of the process of EU integration and modernization of the financial sector, the Government will face two fundamental policy challenges:
■ First, to ensure that the performance of the financial regulators in general, and the new capital markets/NBFI regulator in particular, are strengthened to the point where they can perform their duties as home country regulators under the single EU financial market; and
■ Second, to build the capacity of the financial regulators in general, and the new capital markets/NBFI regulator in particular, to move to risk-based supervision of financial institutions.
To meet these challenges, the Government should consider establishing twinning arrange-ments with financial regulators in one or several EU-member countries, and to design and implement, as part of this twinning program, a comprehensive capacity building program to strengthen the capacity of the Ukrainian regulators up to the standards of other regula-tors on the EU single financial market, and to design and implement a strategy to develop risk-based supervision of financial institutions, both banks and NBFIs. Moreover, Ukraine should take active part in international working groups and Basle committees that develop decisions and promote best standards and practices for financial regulation and supervi-sion, including IAIS and IOSCO.