FSB Confirms Registration on UCITS III Funds
UCITS (Undertakings for Collective Investments in Transferable Securities) was first developed in Europe in 1985 with the main purpose of coordinating EU laws, regulations and administrative provisions relating to collective investments in transferable securities. It has gone through several revisions and amendments, resulting in the latest version, being UCITS III, which modernises and aligns investment regulation of EU-domiciled schemes with the diverse range of innovative investment strategies now available.
UCITS has previously not been of much significance to South African investors and regulators. But the past year has seen significant debate between the SA Financial Services Board and various industry players in determining whether to accept UCITS III in its existing form, reject these funds altogether (which was highly unlikely) or settle somewhere in between by modifying UCITS III directives to suit the SA market? Market players were concerned that the FSB’s approach to UCITS III would be overly conservative and there would be a flight of foreign schemes out the country. Foreign funds being marketed here were concerned that if that FSB localised and tightened UCITS III, there was the risk that some offshore funds currently meeting the approval of the FSB would not pass the localised UCITS III test and could not then be marketed to SA investors.
Through cooperation between the Financial Services Board and Association for Collective Investments, much progress was made in reviewing UCITSIII, identifying areas of concern and ultimately defining an effective solution to concerns which the FSB presented in the interests of protecting investors.
The previous state of affairs was that offshore funds could be marketed in SA as long as they were registered with the FSB. This has been the position since August 1998. The objective was to ensure parity in the regulatory standard between the foreign regulatory environment and South Africa, as well as to ensure that products offerings were of a similar structure and risk profile to local offerings. The Registrar had to be satisfied that the risk profiles of these schemes were not significantly higher than local schemes and that the investment markets they participated in were similar. If the investment funds were not FSB-registered, SA investors could, and can still, buy into such products but the difference being that they cannot be openly marketed here.
The concerns of the FSB in allowing FSB-registered UCITS III funds with expanded powers to continue as marketable products in SA were that these funds use derivatives as part of their investment strategies. They are also permitted to invest in non-investment grade securities. Compared to local funds, the risk profile is somewhat different and more liberal, particularly among the fixed income funds.
But the uncertainty has now been resolved and the status quo effectively continues as long as these foreign funds that elect to use the expanded investments powers meet some additional disclosure requirements set by the FSB.
To date, there are at least thirty four countries that have welcomed UCITS III and SA is now added to the list. Besides being implemented in all EU countries, UCITS III has been fully accepted by non-EU jurisdictions that include Hong Kong, Taiwan, Singapore, Iceland and the Cayman Islands. These are emerging but sophisticated markets, highly comparable to our own.
We achieved certainty and finality on 30 August 2007, when through its Circular 6, the FSB agreed to permit foreign schemes to use financial derivative instruments that include over the counter products. The proviso is that they must furnish the FSB with the prescribed relevant information on risk and compliance. These schemes must also continue to provide certain information in their advertising and promotional documentation regarding differences in regulation and varying requirements in respect of investment limits and exposure to derivatives – as has always been the case for non-local schemes in terms of Notice 2076. So foreign schemes that were previously regarded as suitable for marketing in SA, now continue to be eligible for promotion here, although this is not always guaranteed. The FSB has made it clear it will not merely be rubbing-stamping approvals.
For existing schemes already approved by the FSB, and wishing to make use of the expanded powers granted by UCITS III, the registrar must receive full information relating to risk management, control systems and methods as were submitted to the regulator in the home country where the fund is incorporated. The SA authorities will then consider these submissions on a case-by-case basis but emphasise that it is not their intention to introduce additional or more stringent requirements to the home country regulator. It is merely to assess whether these products are appropriate for marketing to SA investors.
There is a form of special dispensation granted to UCITS domiciled in Luxembourg, Ireland and the UK, which utilise expanded investment powers. They are considered acceptable for continued promotion in SA as long as they meet the additional disclosure requirements, as the regulatory requirements in these jurisdictions have traditionally satisfied the FSB. This policy does not create preferential treatment but merely indicates that these jurisdictions, where the bulk of the schemes come from, are acceptable for continued promotion. This policy is also relevant to umbrella funds where the top fund could be registered in a jurisdiction like Jersey but the underlyings are domiciled in Ireland. In cases like this, the FSB would adopt a look-through approach to the ultimate jurisdictions at the lowest level.
Through SICAV fund registrations in Luxembourg, Franklin Templeton complies with all UCITS III requirements and following on from these recent developments, intends registering additional UCITS III compliant funds in South Africa in the near future in accordance with Circular 6.
With regard to new applications to be registered in SA, these continue to be considered on a case-by-case basis. Risk management and control systems information must be submitted as well with the first-time application. These funds also need to state that their operational policies are appropriate to the risk profile of the fund and investors are able to call for them in detail.
The FSB has provided considerable guidance on information it may require from schemes using the expanded investment powers afforded by UCITS III. With regard to financial derivatives, it could ask for details on staff expertise or a description of valuation rules used. It may call for the methodology used to calculate global exposure and leverage or policies for stress testing and scenario analysis.
The role of a regulator such as the FSB is to regulate the investment arena with the objective of maximising investor protection. Part of investor protection is not only to shield the investor from the obvious risks such as liquidity and volatility – it includes offering the investor the widest possible to choice in order to maximise returns. The FSB in this case has achieved an equitable balance by allowing UCITS III funds to be offered in SA but with added disclosures.
The recent ruling by the FSB has implications for financial advisors who market these funds. When an investor chooses to consult a FAIS-registered adviser, that consultant is obliged by law to perform an investment needs analysis. UCITS III also has implications for trustees of retirement funds who would need to be trained and educated as to the appropriateness of these products for their beneficiaries.
Despite the favourable FSB ruling, one still needs to continually address the market misconception that the UCITS III funds automatically mean greater risk. This is not so – it means a broader investment universe and a greater choice of investment techniques available to the portfolio manager which may or may not increase the risk profile of the fund.
The next step in the arrival of UCITS III in SA is to look at developing a domestic equivalent to the expanded powers it affords foreign schemes. There was a concern in the market that by allowing offshore funds with UCITS III approval to remain registered in SA would means unlevel playing fields for the local collective investment scheme providers, as their investment powers are more restricted.
This concern remains a reality as the offshore funds have better and more flexible investment tools at their disposal. But at present, there is nothing to stop local companies from themselves going abroad, registering UCITS III funds in EU jurisdictions and then marketing them back home to the SA investor.
The UCITS debate over the past year was intertwined with proposals that perhaps local schemes should also be afforded similar expanded powers. But these suggestions have, in the interests of expediency, been “delinked” from UCITS III considerations as foreign schemes needed certainty on whether they could continue to market themselves here. In contrast, the matter of expanding local scheme investment powers is a broader and more long-term debate that does not have to be resolved immediately.
Jacob Mhlangu of the SA Financial Services Board says that the collective schemes industry and authorities are considering the present imbalance between local and offshore funds and are taking steps to create parity between the two. “We have a temporary situation where the playing fields are uneven but all parties are consulting so as to issue legislation and guidelines that corrects the situation. We should see resolution definitely within the next few months, into 2008.”
The SA market – investors and Independent Financial Advisers – should not be afraid of the greater choice that UCITS III creates. More players and more funds open up the market, increase competition, and should ultimately lead to better customer service all round. The SA investor needs as wide a choice of products as possible, especially during bear markets, where the invaluable use of derivative strategies and guarantees are sanctioned by UCITS III. After a lengthy process of engagement with ACI and FSB, Franklin Templeton is extremely satisfied with the decision taken by the FSB and look forward to expanding our fund range in South Africa.
By Michael King, Regional Head Africa, Franklin Templeton
