Regulation 28 - Pros and Cons and What’s the Fuss

The Background

After months of engagement between the Retirement Fund Industry (RFI) and National Treasury (NT), the new Regulation 28 of the Pension Funds Act, No. 24 of 1956 (Reg28) became effective 1 July 2011. As with most new pieces of legislation, obstacles only truly present themselves in the implementation phase.

The new Reg28 presents a policy shift of NT to incorporate a hybrid of what some may call paternalistic rules coupled with key broad principles, each of which have merit and drawbacks. The old rules-based Reg28 fostered tick-box compliance; loopholes were found to exceed the permissible asset limits and it neglected to guide fund trustees on the appropriate investment strategies.

The Issues

The preamble now codifies fiduciary duties which trustees are required to uphold as the fund retains the responsibility for compliance. A notable inclusion is that funds are now required to assess factors which may materially affect the sustainable long-term performance of a fund’s assets including factors of an environmental, social and governance nature.

The new Reg28 introduces concepts of economic exposure and look-through which was intended to clamp down on corporate structures and guaranteed products used in the past to circumvent asset limits based on their legal form. Funds are now required to report and disclose on a full-look through basis each underlying instrument’s economic exposure. This new provision has caused administrative complexities when funds such as Retirement Annuity Funds (RA’s) invest in policies or unit trusts as disclosure is required per instrument irrespective of the vehicle.

The Registrar did, however, award the RFI a reprieve on disclosure by incorporating a five per cent de-minimis rule; if an asset held is less than five per cent of a fund’s total assets, it may be disclosed in the category to which the predominant underlying asset relates.

The Scope

The permissible asset classes of the new Reg28 remained largely unchanged, however, additional capacity was granted to hedge funds, private equity funds, unlisted/alternative debt and other listed commodities. The most notable change can be seen by the increase in non-government guaranteed debt limits from 25 to 75 per cent of a fund’s total assets.

Reg28 has always required that funds as a whole be compliant. This has resulted in some members being able to be fully invested in, for example, off-shore equities in their RA’s. The new Reg28 now requires that individual members offered a choice in respect of the investment of individual contributions in a fund be compliant.. NT has been criticised in their paternalism as individuals are limited to the maximum 75 per cent equity limit (local and foreign), irrespective of age.

The Consolations

NT did recognise the practical implications of this provision and allowed individual members who had investments prior to 1 April 2011 to not comply with the new Reg28, provided that the contractual terms of the investment would not change. Due to the complexities of fund and member compliance the Financial Services Board (FSB) has released two exemptions, one which now requires funds to report, within 90 days after each quarter, any instances where the fund or member may have exceeded any limits (which include market value movements). These reports for quarter one and two are due by 30 September 2012.

One of the complexities is obtaining an instrument’s economic exposure in, for example, a unit trust fund of funds as the underlying fund managers are reluctant to release their intellectual property. The managers have in principle agreed to disclose all holdings quarterly in arrears to facilitate the reporting of compliance in the specified format, as prescribed by the FSB.

The RFI has implemented intra-quarter compliance by making use of intended maximum limits provided by the unit trust companies. These limits are used to ensure fund and member compliance by making use of the overall asset class limits of the underlying building block unit trust fund. This ensures that at the point of investment, the member and the fund are compliant at asset class level.

The Cost and Benefit

The overall cost of compliance is yet to be determined but will ultimately be borne by the individual. In return for this cost, the individual is rewarded by the additional oversight of the FSB and the principles now codified into the new Reg28.