Regulation of private equity managers: What you need to know

While private equity funds are not regulated in South Africa, managers of such private equity funds are subject to the Financial Advisory and Intermediary Services Act (FAIS Act) and to the Financial Sector Conduct Authority (FSCA) in terms of the Financial Sector Regulation Act. Fund managers should also take note of the Conduct of Financial Institutions Bill (COFI Bill) which will soon be enacted

Private equity is an alternative investment class, consisting of capital that is not listed on a public exchange.  Private equity is composed of funds in which investors directly invest in, subject to various conditions.  Investors seek out private equity funds to achieve returns higher than is typically earned in public equity markets.

Private equity funds typically take the form of en commandite partnerships which is comprised of a general partner and a number of limited partners.  The general partner, with unlimited liability in respect of its management function, is responsible for the day-to-day business of the private equity fund, while the limited partners are passive investors and have no involvement in the day-to-day business of the fund and enjoy limited liability.

Typically, the general partner outsources the discretionary fund management services to a discretionary fund manager that is tasked with making the investment and disinvestment decisions on behalf of the partnership.

While neither the Collective Investment Schemes Control Act nor the FAIS Act requires private equity funds to be licensed or authorised, the discretionary management function is a regulated financial service.  The definition of “intermediary services” in the FAIS Act requires that fund managers obtain a Category II authorisation to provide discretionary investment management services.  Should the outsourced manager only provide investment advice to the general partner, with the general partner implementing any investment decisions itself, the manager will only require a Category I authorisation.

The COFI Bill represents the next phase of South Africa’s financial sector remodelling towards a Twin Peaks model.  Being the entity-facing part of the model, the COFI Bill is expected to improve the conduct requirements in existing financial sector laws.  This will have a significant impact on the private equity and venture capital industry.

For the first time in South African financial regulation, the COFI Bill will include alternative investment products which indicates the FSCA’s intention to tighten regulation and unify the conduct requirements for financial institutions.

In pursuing uniformity across the financial sector, the COFI Bill proposes to regulate alternative investment funds.  An “alternative investment fund” is currently defined as an arrangement which raises capital from two or more financial customers to facilitate the participation or interest in and the subscription, contribution or commitment to a fund or portfolio, with a view to investing such capital in accordance with a defined investment policy for the benefit of such financial customers, who proportionately share in the risk and benefit.

The COFI Bill provides that the alternative investment fund may be in any legal form, including in a company, in terms of a contract, by means of a trust or a partnership.  However, the manager of the private equity fund must be incorporated in terms of the Companies Act.

This definition covers alternative investment funds used for pooling, with the result being that private equity funds will have to be licensed.  There is yet to be clarity on which entities involved in a private equity fund, especially where it is in the form of an en commandite partnership, will require a licence.

While alternative investment funds may not be regulated at present, the much anticipated COFI Bill is a step towards to the FSCA’s goal of ensuring sufficient regulatory oversight in respect of a presently unregulated investment class.  The COFI Bill has been promised since 2018.  The latest projection is that it will come into force during 2022, but that is not a certainty.

First published by: Financial Institutions Legal Snapshot