Asset managers get to grips with Regulation 28

The amended Regulation 28 of the Pension Funds Act came into effect on 1 July 2011, with retirement funds benefiting from an additional six-month implementation period. The reform process aims to protect vulnerable pensioners and fund members as well as closing any loopholes in the existing legislation and reducing systemic risk.

Major changes to the regulation include:

1. Compliance at member level whereby each member of a retirement fund must be compliant;

2. The explicit requirement to comply at all times;

3. The requirement to perform reasonable due diligence before investing in an asset;

4. The application of the "look through” principle, which involves including each underlying instrument for reporting purposes (with the exception of hedge funds and private equity funds);

5. Significant changes to respective asset class limits and groupings, aimed at encouraging diversification among funds through the use of different asset classes, and favouring listed instruments over unlisted ones;

6. The entrenchment of the principle that a fund’s assets must be appropriate for its liabilities;

7. The requirement that trustees integrate ESG aspects into their investment decision-making process.

The complexity and level of detail demanded by the regulation created numerous compliance challenges for the investment industry, and asset managers have had to beef up their record keeping, monitoring and reporting systems to provide the level of detail required.

Local asset managers using offshore managers for their global investments will struggle to comply, as foreign assets are often invested in pooled portfolios offshore. The required "look through” information is either not available or provided after considerable delay.

Some uncertainty remains with regards the interpretation and treatment of money market instruments too. National Treasury deliberately excluded a definition of these instruments, leading to disagreements between industry players as to their classification. The board notice determining the treatment of derivatives has not yet been promulgated either.

The asset management industry is engaging the regulators (and offshore managers where applicable) to resolve these issues.

The new regulation places onerous responsibilities on retirement fund trustees. Trustees will need to ensure their asset managers have adequate administrative and compliance systems to provide the necessary data and reporting within the required time frame and in the prescribed format.

A proposed solution is for asset managers and their clients to implement pre-trade compliance monitoring systems. These systems allow an asset manager to assess the effect of the proposed "buy” or "sell” decision on the total portfolio before the trade is executed. If the trade results in a breach of the new Regulation 28 requirements it will be blocked.

Where trustees use multiple asset managers, the services of an asset consultant or investment platform may be required to achieve full compliance with the regulation at a total fund level. Platforms or asset consultants can manage the entire monitoring process, including:

1. Collecting data (daily);

2. Monitoring and identifying breaches;

3. Collating the data at different fund levels such as asset manager level, building block member choice level and total fund level;

4. Reporting breaches to the fund representatives; and

5. Compiling the prescribed certificates for submission by the fund to the regulator.

Trustees opting for the multi-manager route outsource these functions (excluding actual submission) to the multi-manager. Regardless of the platform used, a clear process relating to breach reporting must be defined.

Employed South Africans have almost R3 trillion invested in different retirement funding vehicles. Most of these individuals are wholly dependent on this money for their retirement. The measures adopted by Regulation 28 serve to protect the interests of these members.

The message being sent by the regulator is strong: Rogue or irresponsible trading by asset managers will not be tolerated – while trustees must execute their fiduciary duties in a responsible fashion.