Could Regulation 28 drive retirement fund consolidation?

The new Regulation 28 of the Pension Funds Act could drive a wave of consolidation in the retirement fund industry, due to the sheer volume of compliance and reporting requirements and the resulting strain on funds’ resources.

“The sheer volume and complexity of work that compliance with the new Regulation 28 entails will result in increased costs and encourage further consolidation of retirement funds,” says René Swart, Head of Investment Accounting and Regulatory Reporting at RisCura, an independent analytics provider and investment consultant.

Regulation 28 governs the type of investments retirement funds can hold, and in what proportions. Originally signed into law in 1962, the last time it was amended was 1998. A revised version was promulgated in February this year, and became effective on 1 July 2011. The first reports required under the new regulation are due in April 2012.

“The revision of Regulation 28 was crucial, as markets have changed significantly,” says Swart. “The extent of financial instruments available to retirement funds has expanded over the years and alternative investments, such as hedge funds and private equity, weren’t explicitly dealt with in the previous regulation. Including these in the new version as separate asset classes encourages trustees to consider these options and to structure the optimal investment combination for their members. At the same time, by setting clear limits, it protects members from overly risky investment strategies.”

The relatively small number of companies listed on the JSE makes private equity an attractive investment alternative. According to a 2010 survey by SAVCA and KPMG, assets under management by South African private equity funds have increased exponentially to over R97 billion.

The inclusion of private equity will provide trustees another avenue to explore BBBEE and ESG (environmental, social and governance) factors when investing, another new Regulation 28 requirement. In Swart’s opinion, “Private equity funds are more likely to have comprehensive ESG strategies than traditional equity funds. The integration of ESG is a key component of the new regulation and access to private equity will allow for additional avenues to pursue responsible investment.”

From a trustee’s perspective, however, demonstrating compliance with the new regulation is data intensive, complex and time-consuming, and the first deadline is looming.

By the end of the year (December 31), trustees will have to start actively monitoring their funds’ compliance. Many funds won’t be compliant. Where this is the case, trustees will have to map out a route to compliance, submit this to the Financial Services Board (FSB) and apply for exemptions, if necessary. And this is just the tip of the compliance and reporting iceberg.

From January 2012, funds will have to demonstrate daily compliance with the asset limits at both a fund and a member level. This means that the compliance status of every investment permutation offered to members needs to be checked and reported on. According to Swart, “Many pension and provident funds offer member choice in the form of life stage portfolios that can be selected. All of these separate funds must be compliant and reported on.”

Trustees will have to submit reports quarterly to the FSB detailing any breaches at a fund or member level that occurred during that quarter. Under the old Regulation 28, funds could report their position once a year, on a point-in-time basis.

Trustees must also have an investment policy statement (IPS) in place by 31 December 2011. The policy should cover the fund’s approach to trustee education, BBBEE and ESG issues; outline how it will match its assets to its liabilities; its due diligence process on all investments; how it will monitor compliance by its service providers; and how it will ensure understanding of the fund’s changing risk profile.

“Regulation 28 has changed the face of the retirement fund industry,” says Swart. “In addition to emphasising members’ interests and trustees’ obligations, it compels trustees to adopt a liability-based approach to investing and to take a long-term view.”