Winning more money for pension funds

Early in 2006 the Financial Services Board (FSB) imposed stiff penalties on a number of pension fund administrators who had used a process known as 'bulking' to skim R500 million from pension fund members.

'Bulking' is a process in which funds under administration are combined to achieve better interest rates. Financial benefits from such transactions were retained by pension fund administrators instead of being passed on to the fund members.

When the FSB reported to parliament in June 2006 they referred to a number of other 'unfair' practices which they would be investigating. These included the profits generated by scrip lending. It appears that various fund administrators regularly lent the shares held by their pension funds for this purpose - and it is unclear whether the fees earned on such activities were applied to the benefit of fund members.

FSB fires another broadside

Nearly 12 months later it appears the FSB is ready to get tough on companies that have benefited from the practice of scrip lending at the expense of pension funds. The FSB's deputy executive director, Dube Tshidi was reported on fin24.com as saying: "We are looking at scrip lending. I can assure you that justice will be done from day one."

The argument is not about whether or not the practice of scrip lending is financially sound. Both scrip lending and 'bulking' are sensible financial strategies which generate additional returns. The problem relates to how these additional incomes are reported - and to whose benefit they are applied.

To retain the benefit from such activities, companies need to have obtained their clients permission. If, as most asset managers contend, the pension funds were aware of and supported the practice, they have little to worry about.

However, if it emerges that the scrip lending transactions were conducted 'under-the-table' we could see more 'admission of guilt' type payments to the benefit of pension funds.

What you need to know about scrip lending

The South African Reserve Bank acknowledges that "Scrip lending and borrowing are an essential element in every liquid stock exchange. In fact, without scrip lending and borrowing, stock exchanges would find it very difficult to maintain smooth flows of trading activity."

Scrip lending began in South Africa as far back as 1995. Pension funds would become scrip borrowers - loaning the shares held in their portfolios to various asset managers who used the stock to facilitate hedging (selling) transactions in the market. It is not clear if the asset managers then passed the 2% to 3% scrip lending fees back to the pension funds concerned.

There is no accurate indication of the size of the local scrip lending market - but estimates are that annual transactions could run to R100 billion.

Redirecting the flow

The life insurance industry has come under heavy fire in recent years. The first concession from the industry cost it a massive R3 billion rand by way of a statement of intent between the life industry and National Treasury. Through this statement the industry agreed on certain minimum termination values for policies going forward, and offered compensation to individuals who had previously been disadvantaged by such practices.

"RA funds, endowment policies and other related products that were terminated, or that had premium reductions, at any stage between 1 January 2001 and the implementation date will be enhanced to a minimum value of 65% of fund value or investment account.

Policyholders of savings policies like endowments and members of RA funds who reduce or stop their premiums after the implementation date, will receive minimum values of 70% if these policies remain on the books of the insurer, and 60% if they do not."

The FSB is intent on keeping the industry honest. The practice of spotting questionable financial behaviour and forcing restitution will certainly discourage pension fund administrators and other financial service companies from similar behaviour in the future.

Editor's thoughts:
The pension fund industry has been the subject of a number of regulatory investigations in recent times. First the industry had to compensate pension fund members for unfair early termination practices. Then Alexander Forbes and others were punished for 'secret' bulking practices. Today it appears that asset managers will have to cough up the fees earned from scrip lending transactions which were perhaps unjustifiably withheld from pension funds. Do you know of any other questionable practices that might be flagged by the FSB in the future? Send your thoughts to gareth@fanews.co.za.