Regulation 28 - Regulating the pension investment environment
Certain key principles introduced through the proposed amendments to Regulation 28 of the Pension Funds Act will have a material impact on the pension investment environment.
Earlier this year the Minister of Finance published draft amendments to Regulation 28 of the Pension Funds Act. Interested parties were requested to comment on this first draft by 16 April 2010. Publication of a second draft that incorporates these comments is expected to be published by November 2010, with comments due by the middle of December 2010.
Sensible objective
The proposed amendments aim to allow for more efficient and effective portfolio management and proper disclosure of investment vehicles, by taking account of modern investment products, like derivatives, as well as the market developments over the past ten years.
The draft regulations do not drastically alter the asset classes in which pension funds may invest, nor the limits currently in place in respect of those asset classes. However, some key principles that will have a material impact on the pension investment environment, are introduced.
Look-through principle
A significant proposed change is the application of the look-through principle. This will result in a pension fund’s investment exposure, in respect of insurance products, being tested with reference to the ultimate underlying investments.
Regulation 28 currently makes no provision for the look-through principle, and this omission means that it is possible for pension fund investment managers to avoid prudential limits by investing through layers of investment vehicles in order to conceal the underlying exposure. The proposed amendments provide for the application of the look-through principle when calculating derivative and foreign asset exposures, as well investments in an underlying asset class through another fund.
Retirement annuities
Under the current law, retirement annuity policies that provide a guarantee are excluded from Regulation 28 limits. This allows insurers to offer retirement savings products that enable trustees to exceed the limits prescribed in Regulation 28. In effect, these products allow for the by-passing of prudential limits with impunity. The proposed amendments seek to remove this exemption. This development could pose challenges for providers of hedging solutions and derivative instruments.
Derivatives
A further notice will be issued specifically with regard to pension fund’s investment in derivative instruments. The draft regulation still permits investment in derivative products for purposes of efficient portfolio management and hedging against other fund investments. However, it cautions that the Registrar of Pension Funds will adopt a tough line with regard to the use of derivatives for gearing and leverage.
Another significant proposed change is that the Registrar will prescribe which credit rating agencies pension funds may consult, and as a tool to assist the registrar, credit rating bands are to be created.
Defining the playing field
Definitions have been added or clearly specified in order to accommodate the increased creation of new products like derivatives, as well as changes to governing legislation across the financial services sector that impact on pension funds and pension fund management.
In the draft regulation, Islamic investment instruments are also defined, to create compliant long- and short-term fixed income type investments. Existing provisions do not facilitate an Islamic-compliant pension fund’s scope to diversify risk, as current regulatory design encourages investment in interest-bearing products, which are prohibited under Islam.
Engage with the process
The draft regulation and its covering notice display a clear intent to engage with relevant stakeholders regarding fundamental questions around appropriate investment of pension fund’s assets. Interested parties should make use of the opportunity to comment when the second draft is published.
