KEEPING UP WITH LEGISLATION

Transcription

1 KEEPING UP WITH LEGISLATION Hot Topics I October 2017

2 HOT TOPICS I OCTOBER 2017 Contents Page Preface 2 Acronyms used in this workbook 2 Twin peaks arrives: the Financial Sector Regulation Act 2017 becomes law 3 New default regulations to improve outcomes for retirement fund members 9 The Protection of Personal Information Act moves closer to implementation 17 What do trustees need to know about the King IV Code on corporate governance? 19 How are retirement funds affected by the draft Taxation Laws Amendment Bill 2017? 25 A closer look at what a hedge fund is and how it is regulated 31 A round-up of Pension Funds Adjudicator cases 35 People we can thank for the writing of this workbook is: Fiona Rollason Vickie Lange Nancy Andrews Tertius Teichert Zeenat Patel Lesley Ndlovu Ayanda Shabalala Michael Prinsloo The issues surrounding trustee duties are complex and depend entirely on the particular circumstances facing each fund. Trustees must in all cases take their own decision on issues based on their particular fund s circumstances at the time. It is for this reason that trustees can t simply rely on what we ve discussed here today, neither should they regard our discussions as advice. Trustees should get specific assistance where they are uncertain of the consequences or reasonableness of any contemplated action. The information in this document belongs to Alexander Forbes. You may not copy, distribute or modify any part of this document without the express written permission of Alexander Forbes. Alexander Forbes Financial Services is a licensed financial services provider (FSP 1177). Taking action based on information provided While care has been taken to present correct information, Alexander Forbes and its directors, officers and employees take no responsibility for any actions taken based on this information, all of which require financial advice. For further details of our services please contact our office in Johannesburg: Telephone: +27 (0) Fax: +27 (0) info@aforbes.co.za 1

3 ALEXANDER FORBES Preface The retirement fund industry is constantly faced with changes to legislation, regulation and reforms. It is therefore crucial that employers, management committees and trustees keep abreast of the various changes as these have a bearing on benefit offerings. In this environment, it is vital to have these changes distilled into practical implications. Understanding how policy is being shaped for the retirement fund environment provides trustees and employers with valuable information on how to structure their retirement fund, people and communication strategies. Hot Topics provides trustees and management committees with an update on some of the significant legislative and policy changes relevant to our environment to aid in this process. In this Hot Topics workbook we will keep you posted on the implementation of the twin peaks model of supervision as the Financial Sector Regulation Act 2017 becomes law. This is followed by the new default regulations and how they aim to improve members outcomes. We also provide an update on the status of POPI. We go on to explain what trustees need to know about the King IV Code on corporate governance and provide examples of how funds can demonstrate their compliance with the King IV report. Our legal expert also discusses the impact of the Taxation Laws Amendment Bill 2017 on retirement funds. We ll take a look at hedge funds and their regulatory environment before we close off with Pension Funds Adjudicator cases. We trust that you will find this session insightful and helpful, and we invite you to share your feedback with us as we continue to strive towards bringing you really Hot Topics! Regards The Hot Topics Team Acronyms used in this workbook Acronym CISCA CRISA DTA FAIS FSB FSCA FSRA ITA LTIA NEDLAC PA PFA QI SARB TCF TLAB Name Collective Investments Schemes Control Act Code for Responsible Investing in South Africa Double-taxation agreement Financial Advisory and Intermediary Services Act Financial Services Board Financial Sector Conduct Authority Financial Sector Regulation Act Income Tax Act Long-term Insurance Act National Economic Development and Labour Council Prudential Authority Pension Funds Act Qualified investor South African Reserve Bank Treating Customers Fairly Taxation Laws Amendment Bill 2

4 HOT TOPICS I OCTOBER Twin peaks arrives: the Financial Sector Regulation Act 2017 becomes law 3

5 ALEXANDER FORBES Twin peaks arrives: the Financial Sector Regulation Act 2017 becomes law The President of South Africa has signed the Financial Sector Regulation Act into law. This act introduces the twin peaks regulatory framework to South Africa. The minister of finance must still decide on the effective dates of the act. Different effective dates will apply to different sections of the act. The purpose of the act Achieve a stable financial system that works in the interest of customers Supports balanced and sustainable economic growth in South Africa The act will establish a regulatory and supervisory framework that promotes: financial stability safety and soundness fair treatment and protection of customers efficiency and integrity of the financial system prevention of financial crime financial inclusion transformation of the financial sector confidence in the financial sector If there is any inconsistency between this act and another financial sector law, this act prevails. Who and what is covered by the act? Several definitions have been included in the act. These are the most critical for this discussion: Financial institutions Product and service providers and persons licensed under financial sector law Financial products A long-term insurance policy and benefits provided by retirement funds Financial services Giving advice and providing administration services Financial stability The ability of financial institutions to provide their services and products without interruption and despite changes in economic circumstances Financial sector law Includes the Pension Funds Act (PFA) and the Long-term Insurance Act (LTIA). New authorities created under the act Regulatory bodies and committees have been established in the act. Some are: Financial System Council of Regulators This council facilitates cooperation, consistency and collaboration between various government representatives and regulators. Financial Sector Conduct Authority This is a market conduct regulator that promotes the fair treatment of customers and provides financial education. Prudential Authority This is a juristic entity operating in the administration of the South African Reserve Bank (SARB). It promotes the safety and financial soundness of financial institutions and protects customers against the risk of financial failure of an institution. Financial Sector Conduct Authority This is the regulatory authority responsible for funds and administrators. The Financial Sector Conduct Authority (FSCA) will regulate and supervise funds in line with this act, the PFA and the Treating Customers Fairly (TCF) framework. The governing body of funds, namely trustees and principal officers, must make sure it complies with all its obligations under financial sector law. The FSCA will prioritise the use of its resources based on the significance of a risk. They will use an outcomesfocused and risk-based approach to the performance of their functions. They must act without fear, favour or prejudice. The head of the FSCA will be the commissioner. There will be between two and four deputy commissioners appointed, all with expertise in the financial sector. They will: form the executive committee of the FSCA be responsible for the management and administration of the FSCA enter into memoranda of understanding with the Prudential Authority (PA) adopt the regulatory strategy of the FSCA The FSCA will publish its regulatory strategy, which will explain what its regulatory and supervisory priorities are for the next three years. Its strategy will set out the guiding principles for how it will perform its functions. 4

6 HOT TOPICS I OCTOBER 2017 Regulatory instruments A regulatory instrument includes: prudential standards conduct standards joint standards The act sets out the procedure to be followed when issuing any new regulatory instruments. This includes a publication and consultation process. There is a separate process to follow if the regulatory instrument must be issued urgently, for example where consumers are being prejudiced. There are extensive topics that instruments may deal with, including: fit and proper requirements governance and duties of key persons, such as trustees operational requirements financial management record- keeping and data management outsourcing business continuity conflicts of interest safekeeping of assets Prudential standards These are issued by the Prudential Authority (PA) and relate to ensuring financial stability. Conduct standards These will be issued by the FSCA. They can apply to financial institutions (funds) or key representatives (trustees and principal officers). The conduct standard will aim to: ensure the efficiency and integrity of financial markets ensure institutions and their representatives treat their customers fairly ensure financial literacy programmes are appropriate reduce the risk of financial crime help maintain financial stability resolution of complaints, including redress disclosure of information to customers principles, processes and procedures for the refusal, withdrawal or closure of a product or service to customers. Conduct standards can: declare a specific conduct to be an unfair business practice assist funds to implement the Treating Customers Fairly principles. Joint standards These are issued jointly by the PA and the FSCA. Licensing Anyone providing financial products and services must be licensed to do so. Where there is existing law regarding licensing, such as the PFA, that law will still apply unless the act specifically overrides the PFA. The act deals with the process of applying for a license and what happens if a license is suspended or revoked. There is a specific section in the act that deals with licenses that are granted in terms of financial sector laws, which would include the PFA. No license may be issued, varied, suspended or revoked by one regulator without the agreement of the other regulator (the PA and FSCA going forward). Comment We assume that the FSCA would continue to register funds under the PFA but going forward, the PA would need to agree to the issuing of the licence. It will be interesting to see if the cancellation of a fund s registration constitutes a revocation of a license under the act, which would need the PA to agree with that cancellation. When it comes to the fair treatment of customers, a conduct standard can be issued that relates to: design and suitability of products and services promotion, marketing, distribution and advice in relation to products and services 5

7 ALEXANDER FORBES Information gathering, supervisory on-site inspections and investigations The FSCA, which will be the regulator for funds and administrators, can request information or documents from funds and administrators in writing. This request must be relevant to help the FSCA perform their functions or to assess risk of compliance or contraventions of the PFA. The FSCA may engage in mystery shopping to gather information relevant to its functions. On-site inspections may take place with prior notification to the entity. The purpose of the inspection could be to assess compliance or a contravention of legislation. The act sets out conditions relating to an inspection. The FSCA may issue a written directive instructing the entity not to destroy or remove any business document. No one may intentionally or negligently interfere with an inspection. The FSCA may appoint an investigator to carry out an investigation. The regulator should have a reasonable suspicion that a contravention has occurred or may occur to launch an investigation. The act sets out the powers of investigators to question individuals and require documents to be produced. Any questioning would be done under oath and a person being questioned is entitled to have a lawyer present to assist them. An investigator can enter premises with prior consent. They can also enter premises without prior consent or notification if: they have a warrant to do so, which has been issued by a judge or magistrate the head of the FSCA believes a warrant would be granted and a delay would defeat the purpose of the search of the premises The act sets out conditions under which any search of premises must be conducted. No one may intentionally or negligently interfere with an investigation. A person who is answering questions or has to produce a document can refuse to do so if they would incriminate themselves. Notwithstanding any objection, the investigator may still require the information to be provided but that information is not admissible in criminal proceedings in most circumstances. Enforcement Guidance notices May be issued by a regulator on the application of financial sector law. These are for information and are not binding. Interpretation rulings Are statements issued about the interpretation and application of financial sector law. They aim to promote clarity, consistency and certainty on the law. These rulings could be changed or revoked if the law changes or a court decides on another interpretation. These will be published for public comment before being finalised. Directives Will require a financial institution or a key person at a financial institution to perform the action specified in the directive. This could happen where the institution is not treating its customers fairly or has or is likely to contravene the law. The directive could state that: products or services should stop being provided contravention must be remedied a person could be removed from their function in relation to the institution. There are specific requirements to be followed by the regulator when issuing a directive, especially where the directive involves the removal of a person from a position. This power applies in addition to the power to issue directives under the PFA. Enforceable undertakings These are given by a person to the regulator about that person s future conduct in relation to the applicable financial sector law. If the regulator accepts the undertaking, then it is enforceable by the regulator. The undertaking could include specific redress to customers. If the person then fails to comply with the undertaking, they could lose their licence. The regulator will publish undertakings. Court proceedings These can be instituted by a regulator to ensure compliance with any financial sector law. Any court order that is issued by the court will be published by the regulator. 6

8 HOT TOPICS I OCTOBER 2017 Debarment orders These can be issued by a regulator against an individual who contravenes a local or foreign financial sector law or an enforceable undertaking or if they try to persuade someone else to contravene a financial sector law. There are requirements to be followed before a debarment order becomes final. Leniency agreements These can be entered into where a person cooperates with an investigation. The extent of leniency will depend on the nature of the contravention, the extent of involvement in the contravention and the extent of cooperation. Administrative penalties Appropriate penalties can be imposed by a regulator against a person that contravenes a financial sector law or an enforceable undertaking. Factors to be considered in deciding what is an appropriate penalty could include: the nature of the offence the seriousness of the offence the duration of the offence the need to deter such conduct the loss suffered by someone if there is a prior offence, the extent of the benefit to the wrongdoer the effect of the conduct the penalty on financial stability whether the conduct was deliberate or reckless. The penalty order will be published. Unless the regulators allow it, no one can indemnify or compensate another person from having to pay an administrative penalty. Ombud Council The Ombud Council will ensure that financial customers have access to affordable, effective, independent and fair dispute resolution processes for complaints against financial institutions about their products or services. The council will perform various functions including: recognising industry ombud schemes promoting cooperation between ombuds resolving jurisdictional overlap between ombuds setting rules for ombud schemes and monitoring the performance of ombuds The council will be managed by the Ombud Board. The board will inform the minister of finance and the regulators about trends in complaints. The head of the council will be the chief ombud, who will be responsible for the management of the council. The chief ombud must convene a meeting of all ombuds at least four times a year. An industry ombud scheme may apply to the council for recognition. In deciding whether to recognise any ombud scheme, various factors will be taken into account by the council. The council will establish a call centre to assist customers in formulating complaints and identify the appropriate ombud scheme for complaints. Financial institutions cannot call their internal procedures an ombud scheme. They must publicise the details of applicable ombud schemes to customers. If there is no industry ombud scheme or statutory ombud scheme for specific products or services, the council can instruct an existing ombud to deal with those specific complaints. Financial Services Tribunal This tribunal is established to reconsider decisions made by a regulator, the Ombud Council, a statutory Ombud or a licensed financial services provider. The decisions that can be reviewed by the Tribunal include: the failure of a decision-maker to make a decision within a required or reasonable time period an act or omission following on from a decision made by a decision-maker The tribunal must be independent, impartial and follow this act and any financial sector laws. The minister of finance will appoint the tribunal members, which will include two retired judges and two people with financial services experience. When a decision by a decision-maker needs to be reconsidered, the tribunal will set up a panel to hear the matter. The minister will invite qualified persons to sit on the panel. The act sets out the timeframes and procedures to be followed to refer a decision to the tribunal, including the right to receive reasons for any decision made by a decision-maker. The tribunal can make the following orders: dismiss the application to reconsider the decision set aside the decision and ask the decision-maker to review their decision set aside the decision, allowing the tribunal to make a new decision The tribunal s order can be made an order of court, in which case it has the same effect as a civil judgment. Any party that is unhappy with a tribunal s decision can go to court to get the tribunal s order reviewed. The tribunal will replace the Financial Services Appeal Board. Fees and levies A regulator can charge fees and levies under this act and the relevant financial sector laws to fund its activities. Fees and levies must be published. Different fees and levies can apply to different types of entities. Information sharing and reporting There is a significant amount of detail in the act about information sharing. In short, regulators, ombuds and state bodies may collect, use, share and disclose information, including personal information, to perform their duties under the act and other relevant financial sector laws. 7

9 ALEXANDER FORBES Regulators must liaise with one another and enter into agreements regarding the coordination of the reporting and sharing of information. Parties must be satisfied that a party receiving information is able to safeguard that information. A financial institution s auditor must, without delay, report to the PA on any matter which may cause the institution to be financially unsound or may contravene a financial sector law. This includes the failure by the fund to perform its reporting obligations where contributions are not paid to the fund. A person can report financial difficulties, contraventions or financial crime to a regulator. A person who makes such a report might not be held criminally liable if they made the report in good faith. Such a person cannot be victimised if they are an employee of the institution. This act applies in addition to other laws which already exist to provide protection for people who properly report contraventions (protected disclosures). Financial Sector Information Register National Treasury will establish and maintain a register to provide reliable electronic access to accurate, authoritative and up-to-date information on financial sector laws. The public will be able to access this register. The act lists all of the documents or types of documents to be published in the register. Offences and penalties There are various types of penalties depending on the nature of any contravention. Examples are: an institution acting without a licence will receive a fine of up to R15 million or imprisonment of up to 10 years, or both an institution failing to report as required under the act will be fined R5 000 for every day the offence continues. The act does not put in a cap on this amount an institution failing to publish or disclose a licence will receive a penalty of R an institution not meeting the requirements of an inspection or investigation will receive fines of between R1 million and R5 million, depending on the offence, and imprisonment in some cases too in the case of non-compliance with an enforcement order, an institution will receive a R15 million fine or imprisonment of up to 10 years, or both There are also fines for regulators, or persons working at a regulator, for their failure to comply with the act. However, there is a specific indemnity for such entities or persons, for loss or damage suffered by someone as a result of a decision or action taken in good faith in the exercise of a duty under financial sector law. The assets, liabilities and employees of the Financial Services Board (FSB) will transfer to the FSCA. Inspections and investigations being undertaken by the FSB will be continued by the FSCA. The FSB Appeal Board and enforcement committee will cease to exist but they will finalise matters they were busy with. In cases underway involving the FSB, the FSCA will be substituted for the FSB. Licences in force before the act will remain in force. The minister of finance may issue regulations to support the act and the regulations may also clarify how transitional arrangements will take place. Changes to the Pension Funds Act The introduction of this act has resulted in changes being required to many other pieces of legislation, including the PFA. New definitions to be added to the PFA include: Authority means the FSCA Inserting a reference to the act Conduct standards, joint standards, prudential standards, register and tribunal. The definitions of FSB, prescribed and registrar have been deleted. A new section deals with the relationship between the PFA and the act. Any reference to the registrar or FSB must be read as a reference to the authority. The authority will have powers under the PFA and the act. Any notice to be published in a Government Gazette will also be published in the register referred to above. A fund could be financially unsound as determined in line with a prudential standard. Housing loans issued by funds will be subject to prudential standards. The FSCA may issue a directive to a fund requiring the rules relating to trustees be amended in certain circumstances. The Pension Funds Adjudicator (adjudicator) will be a statutory ombud. When dealing with complaints, the adjudicator must take into account: principles of equity where appropriate contractual or legal relationships between a complainant and an institution the act. Including equity principles could impact determinations issued by the adjudicator. Transitional arrangements The powers of the PA to ensure financial soundness will be delegated to the FSCA in respect of pension funds for a period of three years. 8

10 HOT TOPICS I OCTOBER for New default regulations to improve outcomes retirement fund members 9

11 ALEXANDER FORBES New default regulations to improve outcomes for retirement fund members The amendments to the PFA relating to defaults were published in the Government Gazette on 25 August These default regulations aim to improve the outcomes for members by ensuring that they get good value for their savings and retire comfortably. Two draft versions of the default regulations were issued for comment in July 2015 and December This final version of the regulations is similar to the second draft version, with the exception of a few minor changes and improvements. The regulations require funds to implement: a default investment strategy (regulation 37) default preservation and portability (regulation 38) an annuity strategy, which is not a default as such (regulation 39) These defaults should be appropriate, simple, cost-effective and transparent. The regulations require that trustees help members in the accumulation and retirement phases of their membership of a fund. Effective date of the regulations and the affected funds Notice 3 of 2017 was issued on 30 August 2017 and exempts all funds registered before 1 March 2018 from the provisions of regulations 37, 38 and 39 until 1 March All funds will have to implement the three different strategies as indicated above and will have to ensure full compliance with the requirements of the regulations by 1 March New and changed provisions in the regulations An exemption clause has been added for regulations 37, 38 and 39. This allows a fund to apply for exemption from all or certain provisions of the regulations, subject to conditions that the registrar may impose. Funds in liquidation are automatically exempt from the regulations. However, closing down funds or funds in the process of deregistration will not automatically be exempt from these regulations. Therefore, these funds will need to make use of the exemption clause. If a provident fund s and provident preservation fund s rules don t allow retiring members to purchase an annuity then the fund will not have to implement an annuity strategy. Provident funds must only establish an annuity strategy if the fund s rules enable the member to choose to buy an annuity. This does not mean that members of provident funds are compelled by these regulations to purchase an annuity on retirement. The annuitisation of provident funds remains under discussion at the National Economic Development and Labour Council (NEDLAC). In the second draft of the regulations, the administration fees related to paid-up members could not be more than the average of the active members administration fee. The final regulations say that the administration fees for paid-up members must be fair, reasonable and commensurate with the cost of providing the administration service to members still in the service of the employer. The regulations apply to all retirement funds with these exceptions: Regulation Description Does not apply to: Default investment strategy Default preservation and portability Annuity strategy retirement annuity funds preservation funds defined benefit funds funds in liquidation retirement annuity funds preservation funds funds in liquidation provident funds and provident preservation funds if the rules don t allow retiring members to purchase an annuity funds in liquidation 10

12 HOT TOPICS I OCTOBER 2017 The second draft of the regulations said that all fees and charges related to the default investment portfolios must be disclosed, as well as the effect that such fees and charges will have on members actual and prospective benefits. The final regulations say that the disclosure must be made on a regular basis to boards and the relevant information must be appropriately disclosed to members. It has been clarified that one or more default investment portfolios can be used as part of the default investment strategy. The definition for annuity strategy now includes annuities, whereas the second draft only included annuity. This provides clarity in that funds are allowed to develop an annuity strategy that can include multiple annuity products rather than just one annuity product. It has been clarified that regulation 28 applies to out-of-fund living annuities that form part of funds annuity strategy. 11

13 ALEXANDER FORBES Summary of key aspects of the regulations Default investment portfolios Retirement funds investment policy statements must make provision for one or more default investment portfolios. The default investment portfolios may differ from member to member, depending on the age or likely retirement date of the member the value of the retirement benefit the actual or expected contributions to the fund the other reasonable factors the trustees consider to be appropriate Default preservation Trustees must offer a default in-fund preservation arrangement to members who leave the service of the participating employer before retirement. Fund rules will need to be amended to allow for employees who leave the employer to automatically leave their accumulated retirement savings in the fund. However, members will have the right to opt out of the fund and withdraw their fund credit in cash or to transfer it to another fund. Members must be given access to retirement benefits counselling before they make a decision to take cash or transfer their benefit. Paid-up membership certificates must be issued by a fund within two months after the fund becomes aware that the member no longer works for the employer. The certificate must show the: In designing the default portfolios, trustees must ensure it is appropriate to members and trustees should consider the objective, asset allocation, fees, charges, risks and returns of the portfolio. The default member investment portfolios must be reasonably priced, well-communicated to members and offer good value for money. Trustees are required to monitor investment portfolios regularly to ensure continued compliance with these regulations. Trustees must consider active and passive options. Performance fees will be allowed but subject to a standard to be issued by the FSB and a regulatory or policy review. Loyalty bonuses or other complex fee structures are not allowed. If a fund has member investment choice then members must be allowed to switch out of the default portfolio at least once a year. This does not mean that funds must implement member investment choice. name, address, registration number and contact details of the fund name, address and contact details of the fund s administrator name, address, identity number, tax number and most recent contact details of the member date the member became paid up date the certificate was issued value of the fund benefit when the member became paid up investment portfolios in which the benefit is invested other prescribed information Investment fees for default portfolios must be the same for paid-up members and active members. Administration fees charged to paid-up members must be fair, reasonable and commensurate to the fees charged for administrative services for active members. No initial once-off charge may be levied for paid-up members when they become paid up. 12

14 HOT TOPICS I OCTOBER 2017 Funds must allow for transfers in from other funds. When individuals join an occupational fund, the fund must, within four months, ask that member for a list of all paid-up membership certificates. The fund must then ask the member if they want to transfer any retirement savings into the fund. The fund must arrange the transfer and cannot levy a charge on the transfer amounts. Trustees must review the annuity strategy at least annually. Living annuities can be provided by: the fund a fund-owned policy an external provider Fund rules must say that paid-up members: cannot pay contributions to the fund cannot have deductions made for risk benefits who have a defined benefit amount must have their benefit converted to a defined contribution amount must be eligible to receive their fund credit on death, retirement and early retirement, in line with the fund rules The investment choice within the living annuity must be limited to four portfolios, which must comply with regulations 28 and 37. The asset-class composition, performance and changes in incomes must be communicated to members. Where the living annuity is paid by the fund or through a fund-owned policy, the fund must monitor the sustainability of income drawn by retirees and make them aware if their drawdown rate is not sustainable. Fund rules can allow for the fund itself to pay annuities, other than living annuities. Annuities provided by a long-term insurer can be part of the annuity strategy too. Annuity strategy For retiring members, funds must have an annuity strategy with annuity options, either an in-fund or out-of-fund annuity or annuities. This means the annuity can be in the name of the fund or the member. An annuity, once chosen or defaulted into, becomes irreversible. To better manage this irreversibility, retiring members can only move into an annuity with their consent. This election by the retiring member makes the purchase of an annuity a soft default by having the member opt in instead of opting out. The annuity should also be appropriate for members, well-communicated and offer good value for money. Trustees must, as far as reasonable, ascertain the: level of income payable to members investment, inflation and other risks in the annuity level of income payable to beneficiaries Members should be given access to retirement benefits counselling not less than three months before their normal retirement date. Insights for trustees The first step is for trustees to develop a project plan to ensure that they implement the relevant default strategies in good time, if they haven t already done so. Trustees who do have the relevant default strategies in place need to review these over the next few months to ensure that these comply with the necessary requirements by 1 March Alexander Forbes recommends that funds start the process sooner rather than later. National Treasury will monitor, assess and review the implementation and effectiveness of the regulations to make sure members are protected against excessive fees, excessively complex and opaque products and certain bad practices. This is an extremely important point and it s therefore imperative that trustees embrace the spirit of the regulations and the objective that the regulations aim to achieve, which is to improve the retirement outcomes for members. There are several provisions contained in the regulations which the registrar may prescribe. This indicates the seriousness of the registrar s objective to ensure appropriate retirement outcomes for members. To the extent that the registrar is not satisfied with how trustees, funds and service providers implement the default strategies and how they comply with the principles, it may impose prescriptions which follow a more stringent rules-based approach. 13

15 ALEXANDER FORBES What should trustees practically do to ensure they work towards compliance with the regulations? Default investment portfolios Trustees must ensure that default investment portfolios are included in the fund s investment policy statement and therefore its investment strategy. Most funds should already have this in place, but check what your investment policy actually says. In terms of regulation 28, funds must review their investment policy statement at least once a year. Also, in line with regulation 37, funds must review the default investment portfolios on a regular basis. Most funds that allow member investment choice will cater for this and the default portfolios in their rules so it won t be necessary for these funds to amend their rules. However, it is prudent to review the rules to ensure they correctly reflect the fund s investment strategy. Funds that offer member investment choice but that don t currently cater for default portfolios will have to do so and ensure the fund s rules are amended. Trustees should review the design of the default investment portfolios to ensure that it is appropriate for members and to ensure that both passive and active investment strategies are considered. Most boards would have already done this as part of their governance processes. However, it s prudent to do a review again taking any other reasonable criteria into account including: objectives asset allocations fees and charges expected risks and returns Generally, where funds allow member investment choice, switching is not limited. Where funds currently limit switching between investment portfolios, they will have to ensure that members are allowed to switch at least once a year. It s important to note that the regulations don t require funds to offer member investment choice if this is not part of the fund s current investment strategy. Trustees should review the fund s communication strategy regarding investments in general. They must ensure that the composition of assets and performance of the default investment portfolios are adequately communicated to members. Trustees must also ensure that the relevant information in respect to fees and charges is appropriately disclosed to members in clear and comprehensible language. 14

16 HOT TOPICS I OCTOBER 2017 Trustees should review the fees and charges of the fund s investments in general and must ensure that the fees and charges of the default portfolios are reasonably priced and competitive. In doing this, the trustees should take all relevant factors into account such as the size of the fund and the asset allocations. To ensure that the portfolios are reasonably priced, the trustees need to apply their minds to the fees and charging structures. Trustees should ensure they fully understand the fees and charging structures as well as the effect on members retirement outcomes. Trustees should ask their asset managers or multimanagers on a regular basis to fully disclose and explain the fees and charging structures. They should also ask their consultants to demonstrate how the fees and charges affect members retirement outcomes. When comparing investment fees and charges, it s important to: compare the total investment charges from each of the asset managers and multimanagers review the benefits relative to the charges, including considering returns net of fees Industry bodies are considering standard disclosures and the FSB may prescribe a format for disclosures. Default preservation and portability Trustees must ensure that their fund s rules are amended to cater for paid-up members who stop working for the employer before retirement. The rules have to specify that: no new contributions are allowed no risk benefit deductions are allowed* defined benefit amounts to be converted to defined contribution amounts they re eligible for their fund credit on retirement or early retirement *Paid-up members are not eligible for insured benefits, such as death, disability and funeral cover. It s important that paid-up members are informed that even though these benefits fall away when they become paid up, their dependants would be eligible for the paid-up benefit amount on their death. regulatory requirements. Fund administrators are likely to request this information on the monthly contribution schedules to ensure that the fund s records are comprehensive enough to comply with the requirements of the paid-up membership certificates. Trustees, together with their asset managers or multimanagers, will have to ensure that investment fees for default investment portfolios don t differ on the basis of the members being paid-up or active. Trustees will also need to consider an investment strategy for paid-up members. Fund administrators will have to ensure that administration fees for paid-up members are fair, reasonable and commensurate with the cost of providing the administration service to members who still work for the employer. Trustees will need to engage with the fund s administrators to ensure that this requirement is met. Trustees will also need to ensure that the fund s administrators don t levy an initial once-off charge when a benefit becomes paid-up. Trustees of receiving funds (transferee funds) should engage with the fund s administrators to find out how they, together with the employer, intend to deal with the requirement to arrange for transfers of retirement savings into a member s new fund if they wish to do so. Fund administrators should provide funds with clarity in respect of their duties and the employer s duties. Trustees will also need to ensure that the fund s administrators don t levy a charge for arranging for these types of transfers. Alexander Forbes is in the process of working through the details of the regulations and will inform funds with an administration appointment what processes will be followed in this regard. PROCESSES They must also provide members with access to retirement benefits counselling before withdrawal benefits are processed. Fund rules will also have to be amended to accept amounts transferred in from other funds. Trustees should engage with the fund s administrators to find out how they intend dealing with paid-up membership certificates. Administrators should outline the process of providing paid-up membership certificates to trustees and confirm what information will be needed by the employer to ensure the paid-up membership certificates meet the 15

17 ALEXANDER FORBES Annuity strategy All types of annuities are allowed as part of a fund s annuity strategy. Therefore, trustees should go through a process to decide on whether to provide in-fund or out-offund annuities or both, depending on the size of the fund and other relevant criteria. It s anticipated that most funds will use out-of-fund annuities and are likely to use both living and life annuities as their fund s annuity strategy. Where trustees decide to use living annuities, the investment portfolios must be limited to four and must comply with regulations 28 and 37. Drawdown levels must comply with a prescribed standard and if an in-fund living annuity is used, the fund must monitor the sustainability of income and inform members if their drawdown rate is unsustainable. Trustees have the responsibility to comply with this requirement and can consider outsourcing the work related to this. Trustees should consult their consultants and administrators in this regard. Trustees must ensure that their members who are no less than three months away from normal retirement age have access to retirement benefits counselling. Trustees must ensure that rules are amended to cater for in-fund annuities where this forms part of the fund s annuity strategy. The rules will also have to allow for the ring-fencing of pensioner assets. These funds would have to appoint an actuary to assist in managing this liability. Trustees should review their communication strategies and, in particular, ensure that the relevant communication and disclosure requirements are taken into account for the fund s annuity strategy. Trustees should, on a regular basis, and in a clear and understandable language, communicate to members the: asset class composition of investment portfolios portfolios performance changes to incomes in respect of living annuities relevant information about all fees and charges Trustees must ensure that fees and charges are reasonable and competitive. Trustees can engage with their consultants to assist with comparisons of appropriate solutions in the market to ensure that fees and charges are competitive. Trustees will have to apply their minds to the fee and charging structures to ensure that they re reasonable. Trustees must review their fund s annuity strategy at least annually. Alexander Forbes consultants will be engaging with trustees over the next few weeks regarding project plans to work towards compliance with the regulations well before the deadline of 1 March Trustees must ensure that the annuity strategy is appropriate and suitable for members. In doing this, trustees should consider all criteria that are reasonably ascertainable, including: income levels investment inflation and other risks the level of income protection for beneficiaries of deceased retirees 16

18 HOT TOPICS I OCTOBER The Protection of Personal Information Act moves closer to implementation 17

19 ALEXANDER FORBES The Protection of Personal Information Act moves closer to implementation We ve been hearing for a long time about the Protection of Personal Information Act. It is law but not all provisions in the act are effective yet. In late 2016, an information regulator was appointed. One of the objectives of appointing a regulator was to issue regulations to the act. The information regulator issued draft regulations to the act on 8 September 2017 for public comment. There is a specific call for the following stakeholders to submit comments: insurers medical schemes administrators pension funds employers working with funds The duties and responsibilities of information officers are set out and they must ensure that: a compliance framework is developed, implemented and monitored measures exist to comply with the conditions of lawful processing a manual is in place to cover processing, categories of data subjects and suitability of information security measures awareness sessions are conducted Where there is an allegation that personal information has been interfered with, the regulator can act as a conciliator between the data subject and responsible person. The aim of the conciliation would be to reach a settlement between the parties. The regulations set out how the conciliation process could take place. Comments must be submitted on the draft regulations by 7 November We are submitting comments through industry bodies we are involved in. We believe this invitation is in recognition of the vast amounts of personal information that is processed by these entities. The draft regulations contain forms, which can be used in specific circumstances, for example: an objection by a data subject to their personal information being processed a request by a data subject for the correction, deletion and destruction of personal information a code of conduct for an industry, profession or vocation consent to direct marketing the submission of a complaint or grievance when a regulator must inform parties about an investigation that will be conducted an investigation enforcement notice or appeal 18

20 HOT TOPICS I OCTOBER King What do trustees need to know about the IV Code on corporate governance? 19

21 ALEXANDER FORBES What do trustees need to know about the King IV Code on corporate governance? The King IV Report on Corporate Governance for South Africa 2016 (King IV) was published in November 2016 and replaces King III in its entirety. It s effective for financial years on or after 1 April King IV contains a retirement funds sector-specific supplement. This supplement sets out 17 corporate governance principles which trustees must endeavour to apply in line with the King IV approach of apply and explain. The retirement funds sector supplement must be read with the main King IV code and applies to all retirement funds. Retirement funds are governed by the PFA and PF Circular 130. In addition, trustees have to take into account and implement the governance principles in King IV. Both King IV and PF Circular 130 are not legislation but rather comprise a set of voluntary principles and standards of best practice for good governance of retirement funds. Concepts which provide context King IV contains several fundamental concepts. It s important for trustees to understand these as they provide relevant context. The objectives of King IV are to: promote corporate governance as integral to running an organisation and delivering governance outcomes broaden the acceptance of the King IV report by making it accessible and fit for implementation across a variety of sectors and organisational types reinforce corporate governance as a holistic and interrelated set of arrangements to be understood and implemented in an integrated manner encourage transparent and meaningful reporting to stakeholders present corporate governance as concerned with an ethical consciousness and conduct and not only structure and process. The key factor underpinning sustainable development is integrated thinking. King IV says that integrated thinking takes account of the connectivity and interdependencies between the factors that affect an organisation s ability to create value over time. King IV presents integrated reporting as an outcome of integrated thinking. An integrated report should connect detailed information in other reports and matters that could significantly affect a fund s ability to create value. The fund should recognise the triple context in which it operates. This means viewing the economy, society and environment in which it operates as being interconnected and as an integrated whole. King IV supports an outcomes-based approach, which strives to experience the intended governance outcomes. The relationship between governance outcomes, principles and practices King IV states that it strives to instill a qualitative approach in which recommended practices are implemented to achieve the principles and realise the intended governance outcomes. Governance outcomes are the benefits that would be experienced if the 17 King IV principles are achieved. The main governance outcomes are: ethical culture good performance effective control legitimacy The 17 King IV principles set the aspirations of good corporate governance. These principles guide organisations on what needs to be achieved to experience the governance outcomes. The recommended practices guide organisations on how to achieve the principles. The key philosophy underpinning King IV is sustainable development. King IV states that sustainable development can be understood as development that meets the needs of the present without compromising the ability of future generations to meet their needs and is a primary ethical and economic imperative. It s therefore important that funds recognise that they re an integral part of society, understand their status as a corporate citizen and understand their stakeholders needs, interests and expectations. 20

22 HOT TOPICS I OCTOBER 2017 The 17 King IV principles are: Category Principle Details Leadership, ethics and corporate citizenship 1 The board should lead ethically and effectively. The board should govern the ethics of the fund in a way that supports the establishment 2 of an ethical culture. 3 The board should ensure that the fund is and is seen to be a responsible corporate citizen. Strategy, performance and reporting Governance structures and delegation Governance and functional areas Stakeholder relationships The board should appreciate that the fund s core purpose, its risk and opportunities, strategy, business model, performance and sustainable development are all inseparable elements of the value creation process. The board should ensure that reports issued by the fund enable stakeholders to make informed assessments of the fund s performance and its short-term, medium-term and long-term prospects. The board should serve as the focal point and custodian of corporate governance in the fund. The board should comprise the appropriate balance of knowledge, skills, experience, diversity and independence for it to discharge its governance role and responsibilities objectively and effectively. The board should ensure that its arrangements for delegation within its own structures promote independent judgement, and assist with balance of power and the effective discharge of its duties. The board should ensure that the evaluation of its own performance and that of its committees, its chair and its individual members, support continued improvements in its performance and effectiveness. The board should ensure that the appointment of, and delegation to, management contribute to role clarity and the effective exercise of authority and responsibilities. The board should govern risk in a way that supports the fund in setting and achieving its strategic objectives. The board should govern technology and information in a way that supports the fund setting and achieving its strategic objectives. The board should govern compliance with applicable laws and adopted, non-binding roles, codes and standards in a way that supports the fund being ethical and a good corporate citizen. The board should ensure that the fund remunerates fairly, responsibly and transparently so as to promote the achievement of strategic objectives and positive outcomes in the short-term, medium-term and long-term. The board should ensure that assurance services and functions enable an effective control environment, and that these support the integrity of information for internal decisionmaking and of the fund s external reports. In the execution of its governance role and responsibilities, the board should adopt a stakeholder-inclusive approach that balances the needs, interests and expectations of material stakeholders in the best interest of the fund over time. The board of an institutional investor fund should ensure that responsible investment is practiced by the fund to promote the good governance and the creation of value by the companies in which it invests. 21

23 ALEXANDER FORBES Application and disclosure of King IV On the King IV apply-and-explain basis, boards must make disclosures to members on their application and implementation of the King IV corporate governance principles and how they have applied it. This means that funds cannot simply have a governance strategy document but must, on an ongoing basis, apply it and evaluate its effectiveness and disclose this to members. It s important to note that the practices contained in King IV are recommended and not required practices. The practices should be implemented on a proportional basis taking several factors into account. Factors relevant to a fund include: size of the membership and assets stated objectives and retirement outcomes of the fund legal and regulatory environment in which the fund already operates governance budget extent and complexity of activities, including impact on the triple context Overall, each board must, in evaluating its governance structures and performance against the standards of PF 130, King IV and the Code for Responsible Investing in South Africa (CRISA), be pragmatic, taking the above factors and any other relevant factors to the fund into account. King IV says that it s not necessary to disclose whether each practice has been implemented or not, as this will not add to the quality of the disclosure. The FSB has for some time now been reviewing PF Circular 130. It s anticipated that the FSB will, in line with its market conduct mandate under the twin peaks model of regulation, issue an updated PF Circular 130 as a directive. This will be binding on funds as it will have legislative authority. It s anticipated that the updated PF Circular 130 will take the relevant King IV principles into account and in so doing, facilitate a more focused and practical approach for compliance with King IV by funds. Ultimately, whatever the fund s governance requirements, trustees must be mindful that each fund must be governed in a manner that ensures favourable retirement outcomes for its members given the identified replacement ratios of the members. Provision of retirement benefits to members and benefits to dependants on the death of a member is after all the primary purposes of a retirement fund. King IV itself recognises that organisations must implement good corporate governance practices so as to help improve the organisation s ability to sustain itself and benefit its members given the economic, social and environmental context in which it operates. King IV contains a roadmap to disclosure on the application of King IV. The roadmap outlines the following steps: Start disclosure by referencing all 17 principles. Consider the recommended disclosures for each of the principles and then explain these in narrative form. Expand the explanation to other practices (other King IV practices as well as other industry practices that apply to the fund s environment) if it s necessary to further demonstrate how these support the achievement of the principle. Also consider any specific guidance contained in the retirement fund sector supplement. Review and make enhancements to ensure users of King IV can make an informed assessment of the quality of the fund s governance in relation to the 17 principles. 22

24 HOT TOPICS I OCTOBER 2017 Practical examples of how to disclose the application of King IV Below are examples of how boards could disclose the application of the King IV principles. Leadership, ethics and corporate citizenship Principle 1 The board should lead ethically and effectively. The board takes its fiduciary duty to make decisions in the members best interests very seriously. In addition, the board had embraced TCF principles and has embedded TCF in its culture, operations and decision-making process. The board aims to ensure that members experience the six fairness outcomes. TCF is supportive of the board s objective to manage the fund with an ethical conscience. The board views TCF and ethics as being interconnected. The board exhibits: integrity competence responsibility accountability fairness transparency This is supported by the fund s implementation of PF Circular 130, which contains good governance guidelines for funds. This is further evidenced in the fund s: code of conduct training policy risk management policy communication policy For example, the fund s code of conduct includes provisions regarding the acceptance of gifts and disclosure of conflicts of interest. The board aims to avoid conflicts of interest. But, where this can t be avoided, it is managed appropriately. In addition, the board: maintains a training register monitors trustee preparation for and attendance of meetings assesses risks through a risk management tool conducts board assessments conducts fairness assessments The board remains fully accountable and responsible to the fund and its members even where functions have been outsourced or delegated to third parties. 23

25 ALEXANDER FORBES Principle 2 The board should govern the ethics of the fund in a way that supports the establishment of an ethical culture. In addition to the board itself managing the fund with an ethical conscience, the board expects the same from the service providers appointed to the fund, such as the: consultant administrator asset consultant asset manager or multimanager actuary The board follows an objective and transparent process when appointing service providers to the fund. The process includes interrogation of the service providers in embedding the six TCF outcomes into their culture, operations and decision-making processes. The board is satisfied that the fund s appointed service providers manage their ethics effectively. The fund s code of conduct deals with whistle-blowing obligations that exist for boards. To date, the fund is not aware of any whistle-blowing cases against the fund or any of its trustees or service providers. Principle 3 The board should ensure that the fund is and is seen to be a responsible corporate citizen. Regulation 28 places a fiduciary duty on a fund to act in the best interest of its members whose benefits depend on the responsible management of fund assets. The board has therefore adopted a responsible investment approach which aims to achieve adequate risk-adjusted returns. The board gives appropriate consideration to factors which affect the sustainable long-term performance of a fund s assets, including factors of an environmental, social and governance character. This approach is documented in the fund s investment policy statement. In addition to regulation 28 requirements, the board only appoints asset managers and multimanagers who are signatories to codes such as the United Nations Principle for Responsible Investment or the Code for Responsible Investment in South Africa. These codes commit the signatories to both considering environmental, social and governance factors, as well as to putting in place policies around active ownership. The board regularly engages with the fund s asset managers and multimanagers to review how they ve implemented the environmental, social and governance factors into their operations and decision-making processes in so far as the fund s assets are concerned. For example, the board typically asks the asset managers and multimanagers to confirm and illustrate the following: How environmental, social and governance issues are considered in their investment process and to provide examples Their approach to proxy voting and what policies are in place To describe their approach to engaging with company management and to provide examples 24

26 HOT TOPICS I OCTOBER Amendment How are retirement funds affected by the draft Taxation Laws Bill 2017? 25

27 ALEXANDER FORBES How are retirement funds affected by the draft Taxation Laws Amendment Bill 2017? The draft Taxation Laws Amendment Bill (TLAB) has been released for public comment and aims to give effect to the tax changes announced in the 2017 National Budget. The following retirement issues are included in the TLAB: The annuitisation requirements for provident funds will be postponed to 1 March Retiring members of occupational funds will now be given the option of preserving their retirement benefits in a retirement annuity fund after reaching normal retirement age. The tax exempt status in respect of pre-march 1998 benefits will apply in cases where one additional transfer to a different fund occurs of benefits originally coming out of a public sector fund. The 12-month limitation on employees joining a newly established pension or provident fund will be removed from 1 March Technical correction to section 11 of the Income Tax Act (ITA) to deal with deductions in respect of contributions to retirement funds. Repeal of the foreign income employment exemption (section 10(1)(o)(ii)) of the ITA) from 1 March 2019, which will apply in respect of all years of assessment commencing on or after that date. 26

28 HOT TOPICS I OCTOBER 2017 The Interdepartmental Task Team on Social Security & Retirement Reform presented the Comprehensive Social Security in South Africa paper to NEDLAC in November 2016, which covered the following: The existing three-pillar social security framework will change over time Pillar 1 (social grants): the means test will be phased out Pillar 2 (Road Accident Fund, Unemployment Insurance Fund, Compensation for Occupational Injuries and Diseases Act, National Health Insurance): improvement of and alignment between the various entities will be implemented. The draft paper on the National Health Insurance was issued earlier this year for comment Postponement of annuitisation requirements for provident funds to 1 March 2019 In 2015, amendments were made to the ITA regarding the tax treatment of provident funds with the aim of promoting the preservation of the retirement fund interest on retirement. These changes would have had the effect of ensuring that provident funds would be treated like pension and retirement annuity funds, and that retiring members of provident funds would be required to annuitise a portion of their benefits accruing after the implementation date. Provident fund members retiring from a provident fund will be permitted to take up to a third of the retirement benefit as lump sum and annuitise at least two thirds. However, this will only be applicable for contributions made to a provident fund after the implementation date. All contributions made before the implementation date and growth on those contributions could still be taken as a lump sum on retirement. In February 2016, the annuitisation requirements for provident funds were postponed for two years until 1 March 2018, in the Revenue Laws Amendment Act of The postponement was done to provide sufficient time for the minister of finance to consult with interested parties, including NEDLAC, regarding annuitisation requirements for provident funds after the publication of the comprehensive policy document on social security. Pillar 3 (supplementary arrangements): auto-enrolment into occupational funds is being considered and a move to a tax credit system, rather than a tax deduction system for contributions A compulsory national social security fund will be established to provide retirement, death, disability and unemployment benefits Institutional initiatives will be implemented to enhance the efficiency and coherence of the social security system. The discussions on the comprehensive paper on social security are still underway in NEDLAC and are far from finalised. The minister of finance was tasked to report back to parliament on the outcome of the consultations by 31 August Since discussions are still ongoing and are far from reaching finality, it s proposed in the TLAB that the implementation of the provisions relating to the annuitisation requirements for provident funds be postponed for one year from 1 March 2018 to 1 March 2019 and be applied in respect of the years of assessment commencing on or after that date. 27

29 ALEXANDER FORBES Transferring retirement fund benefits after reaching normal retirement age Currently, on reaching normal retirement age in terms of the rules of the fund, members can choose when to retire (deferred retirement). The date on which the lump-sum benefit accrues to members for tax purposes is the date on which members choose to retire and receive the payment of their benefit from the fund, and not on the normal retirement age. This change came into effect when paragraph 4 of the Second Schedule was amended from 1 March Submissions were made by the retirement fund industry to National Treasury to consider allowing retiring members of funds to also be able to preserve their benefits after retirement outside of the occupational fund of which they were members. National Treasury considered the submissions made and proposed in the TLAB that, from 1 March 2018, changes will be made to the ITA to allow retiring members to transfer their benefits into a retirement annuity fund from the occupational fund, after retiring from employment. Comment The change in policy was premised on the fact that while members may retain benefits within their funds, they may no longer make contributions to these funds. Retired employees then become inactive members of employer funds. The proposed change, which gives retiring members the option of transferring their retirement interest in their occupational fund to a retirement annuity fund, does not preclude them from making further contributions to a retirement annuity fund once they become members, if the rules of the retirement annuity fund permit this. Transfers to preservation funds are not currently included in the proposal. Allowing retired members the option to transfer to a preservation fund would create a situation where members of pension funds can transfer their benefits into preservation funds, and withdraw the entire benefit in a lump-sum withdrawal, thereby going against the policy of preservation. Through the retirement fund industry the following comments were made on this issue: 1. A member who chooses to defer their retirement benefit should be able to transfer the deferred benefit to a pension or provident fund of which they or she was previously an active member, and where the member is currently a deferred member or a paid-up member who is entitled to retire. This is to allow a consolidation of retirement benefits in one fund. For example, the transferee fund might have a low-cost in-fund living annuity product, which would make it beneficial to consolidate benefits to be eligible for that living annuity. 2. When it comes to allowing for transfers to pension or provident preservation funds, to cater for National Treasury s concerns around the once-off withdrawal provisions in the definitions of preservation funds, it is proposed that these definitions should be amended so that the once-off withdrawal provisions do not apply to retirement benefits that have been transferred into preservation funds. 3. The amendment needs to be revised to clarify whether the member must transfer their entire retirement benefit into one retirement annuity fund or whether they will be allowed to transfer their retirement benefit to more than one retirement annuity fund. The advantage of allowing for multiple transfers is that a member will be able to stagger their retirement dates, that is different retirement dates for each retirement annuity. If the member is allowed to transfer to more than one retirement annuity fund, they should only be allowed to do so if their retirement benefit is over the de minimis amount. 28

30 HOT TOPICS I OCTOBER 2017 Tax-exempt status of pre-march 1998 benefits in public sector funds The ITA currently allows for the tax-free withdrawal of pre-march 1998 benefits when they re withdrawn from: a public sector fund or the fund to which they were transferred (the pre- March 1998 benefits that were transferred from the public sector fund to a private sector fund). Where employers decide to merge or consolidate with other employers forming new funds, the exemption applying to pre-march 1998 benefits no longer applies as that exemption only applies as mentioned above. From 1 March 2018, it s proposed that changes be made to the ITA. These changes would allow for the exemption of pre-march 1998 benefits to apply in cases where one additional transfer occurs to a different fund of the benefits originally coming out of a public sector fund. This change is aimed at addressing the issue of unfairness. Removing the 12-month limitation on joining a newly established pension or provident fund The current limit of a 12-month period for joining a newly established pension or provident fund is restrictive and creates policy anomalies. The consequence of this limit may be that employees can opt to be outside of the retirement saving system, even though they are currently employed and membership of a fund is a condition of their employment as per the ITA. To encourage employees to contribute towards their retirement and remove practical difficulties, it s proposed that from 1 March 2018, the current 12-month period limit be removed so that employees are allowed to join a newly-established pension or provident fund at any time, subject to the rules of the fund. Comment The effect of removing the proviso in the definitions of pension and provident fund is that a fund will be able to disallow current employees to join the fund, which contradicts the aim of encouraging employees to contribute towards their retirement. To avoid this, it s recommended that the proviso should rather be kept and amended as follows: (cc) that persons who immediately prior to the said date were employed by the employer and who, on the said date fall within the said class or classes, may apply to become members of the fund on such conditions as may be specified in the rules. 29

31 ALEXANDER FORBES Deduction in respect of contributions to retirement funds As part of the wider retirement reform objectives, the tax deductibility of contributions to retirement funds was harmonised across all retirement funds through the replacement of section 11(k) from 1 March 2016, where the same deduction now applies to both employer and employee contributions to pension funds, provident funds and retirement annuity funds. The inclusion of the deduction in section 11(k) has created technical complications. The opening proviso states that deductions under section 11 relate to taxable income derived from the carrying on of a trade. However, not all allowable contributions to retirement funds relate to income generated from the carrying on of a trade. Before 1 March 2016, the ITA contained specific exemption for retirement annuity funds under 11(n)(i)(ff), seeing that contributions to retirement annuity funds did not relate to income that is generated from carrying on a trade. The provision dealing with deductions for contributions to retirement funds under section 11(k) has created some anomalies, such as generating an assessed loss from contributions to retirement funds that are above the allowable limit when taxable capital gains are a part of the higher limit. To remove the inconsistencies and anomalies created by the provisions in the ITA that allow for a limited deduction for retirement fund contributions under section 11(k), it is proposed that a new section 11F is inserted to effect this deduction. The proposed amendments will be deemed to have come into effect on 1 March Repeal of the foreign income employment exemption Section 10(1)(o)(ii) of the ITA This section exempts residents who are working outside of South Africa for more than 183 days a year and for a continuous period of 60 days, from paying tax in South Africa on their remuneration from employment. The intention of the section was to prevent double taxation of the same income in South Africa as well as in the country of source when South Africa converted from a source-based tax system to a residence-based tax system. When the exemption was introduced in 2001, South Africa did not have an extensive tax treaty network. Since then, South Africa has an estimated 78 double-taxation agreements (DTAs). The DTAs usually give the country of source the right to tax employment income of individuals in their country if the resident is present there for 183 days, to the extent that the remuneration is taxable there. If not, then South Africa has the right to tax. However, in some foreign jurisdictions, non-residents are not taxed at all so some employees are neither taxed in the country of source nor in South Africa. National Treasury has realised that this exemption creates opportunities for double non-taxation where foreign countries do not impose income tax. Secondly, unequal treatment has been created between public and private sector employees. The current exemption does not apply to public sector employees. Consequently, the exemption will be removed from 1 March Comment This is not a popular amendment. Although DTAs are intended to eliminate double taxation by allocating taxing rights between source and resident states, sometimes both countries have a right to tax 30

32 HOT TOPICS I OCTOBER is A closer look at what a hedge fund and how it is regulated 31

33 ALEXANDER FORBES A closer look at what a hedge fund is and how it is regulated The investment returns achieved on assets such as equities and bonds have been good to date but, looking forward, positive real returns in such an uncertain market environment are likely to be challenging. To prepare for a period of lower real returns (returns less inflation), investors can consider investing in nontraditional or more flexible investments to meet objectives. Alternative investments can address this requirement. There is a wide variety of alternative investments available in South Africa, the rest of Africa and the global market place. The choice depends on the investor s objectives and appetite for the different types of risk that come with each. Investments made in hedge funds are made for: diversification of benefits due to low correlations with traditional investments the potential for larger returns than traditional investments. Hedge funds focus on absolute return rather than performance 1. Hedge funds defined 1.1 Hedge funds offer greater flexibility in execution and a broader mandate through fewer constraints. Hedge funds invest in traditional asset classes but employ different strategies to enhance return within specific risk parameters. Hedge funds are able to: invest in unlisted assets use derivatives use leverage invest long and short use active management strategies and dynamic risk exposures 1.2 Use of leverage Hedge funds have the ability to borrow. For example, a hedge fund may raise R100 million and then borrow a further R400 million to increase the size of their investment. The use of leverage enables a portfolio to amplify position sizing to exploit opportunities in a more sizeable manner. 1.3 Invest long and short Managers take long positions in assets that are expected to appreciate and short positions in assets that are expected to decline. Shorting an asset means that the manager would borrow the asset that they expect to decline and sell it to another investor. Once the asset has declined in value, the manager will buy the stock back at a lower price to return to the lender. 2. Hedge fund strategies Hedge funds can adopt a variety of investment strategies depending on their specific nature and the asset classes they take exposure in. Hedge fund strategies cover single-strategy portfolios and multi-strategy portfolios. 2.1 Multi-strategy portfolios Multi-strategy portfolios invest in a variety of strategies, thereby providing diversification within a single portfolio. Depending on the availability of strategies in a given market, a multi-strategy portfolio would have between three and eight underlying strategies. A manager is able to use their market insight and risk management tools to reallocate quickly between strategies. Exposure to multi-strategy portfolios can be obtained through a single manager or through a fund of fund manager. Where the former is used, managers should be aware of the single-firm operational risk exposure. The purpose of this overview is not to give a comprehensive and detailed explanation of the various single strategies available. This is a complex investment-related subject which is dealt with by Alexander Forbes Investments Limited in a separate research paper. However, we have included some detail on the popular strategy known as long-short equity. 2.2 Single strategy (long-short equity) This strategy involves buying long positions in stocks that are expected to appreciate and selling short positions in stocks that are expected to decrease in value. This style of investing is expected to produce equity-like returns with less volatility than long-only strategies over the long term. This is done by increasing excess returns through both long and short bets and controlling the level of market risk exposure. Managers control the level of market exposure by varying the mix of long and short exposures to reflect the market outlook. If a manager expects the market to rise, long exposure will be increased to have a higher net exposure (long exposure minus short exposure) to the market. If a manager has a bearish outlook, short positions will be increased and net exposure will be negative. 3. Other considerations when investing in hedge funds 3.1 Manager skill Hedge funds are more reliant on investment manager skill (successful active management) than the direction of the markets in general. Returns are therefore expected to be more consistent over time as a result of the lower reliance on the direction of the market. 32

34 HOT TOPICS I OCTOBER Fees Hedge fund fees comprise management fees and performance fees. They are higher than investments in the traditional asset-class space as they are seen to provide a reward structure necessary to attract the best investment talent. The industry has identified that high fees potentially pose a barrier to many investors. Fees in hedge funds have therefore come under pressure. Investors should consider whether the diversifying properties and inefficiencies available for hedge funds to exploit means that returns after fees can be achieved. It s important to understand not only the different types of fees payable but also how they are applied. The fees payable are: Management fees Hedge funds managers either charge 1% or 2% a year on the market value of the portfolio, with the former being the most prevalent. Performance fees These are typically payable on a yearly basis if the portfolio is profitable. The typical performance fee charged is 20% above the hurdle rate. In the case of an investment in a fund of fund structure, a performance fee may also be levied at this level to compensate for the performance of due diligences, managing a portfolio of hedge funds and expenses on the part of the fund of fund manager (admin, custodial, audit and so on). 3.3 High water mark This is an important provision to have to ensure that investors are not charged multiple times for the same profit generation. For example, suppose a hedge fund has a market value of R1 billion and earns a return of 10%, which is equivalent to R100 million. The new market value is R1.1 billion. The next year the fund loses 8%, resulting in a market value of R1.012 billion. The manager does not earn a performance fee. The next year the fund earns 15% resulting in market value of R1.16 billion. Performance fees are payable on the difference between the market value and the high water mark (R1.16 billion to R1.1 billion). 3.4 Hurdle rate The hurdle rate specifies the level of return that must be exceeded before a performance fee can be earned by the manager. For example, if the hurdle rate is 5% and the portfolio earned 10%, then 20% of the difference, so 5%, will be paid out to the manager as a performance fee. In this case 1% is paid to the manager. 3.5 Risks Hedge funds are not without risk. Market risk Hedge funds typically offer low correlation to the market. However, this will depend on the type of strategy adopted. Credit risk This is the risk that the counterparty fails to deliver and is taken on two fronts. The first is that the hedge fund might own a fixed-income security, which has differing degrees of credit risk attached. The second is the credit risk associated with over-the-counter or unlisted derivative instruments. Key man risk Many hedge funds rely on the expertise of one or a handful of key individuals. Their commitment is essential to the success of the fund. Leverage or borrowing risk This is the risk which most people focus on. Under the Collective Investments Schemes Control Act (CISCA) regulations, retail investor hedge funds can borrow to invest up to 200% of the fund but in qualified investor hedge funds, this limit does not apply. Liquidity and pricing risks This is when the underlying securities prove difficult to sell. 33

35 ALEXANDER FORBES 4. Important points Hedge funds offer a unique ability to diversify traditional equity, credit and interest rate risks within a typical portfolio. Hedge funds provide exposure to non-traditional return drivers and play an important role in a diversified portfolio. Performance is reliant more on manager skill than the direction of the market. Hedge funds improve the risk-adjusted performance of an existing portfolio. 5. Regulation of hedge funds Before 1 April 2015, hedge fund managers were licensed and regulated by the FSB in terms of the Financial Advisory and Intermediary Services Act (FAIS), but hedge funds were unregulated. From 1 April 2015, National Treasury has declared the business of a hedge fund to be a collective investment scheme. This means that hedge funds are now regulated by CISCA. National Treasury prescribes the matters which must be provided for in the deed of a collective investment scheme in hedge funds. As a result, the following conditions of investment are now regulated and cannot be varied by the manager: Repurchase obligations A manager must repurchase any number of participatory interests offered to it. Valuation and pricing requirements The assets must be valued independently and, if not valued independently, the valuation must be independently verified. The deed must disclose the frequency and basis on which the assets of a portfolio are to be valued and the manner in which the assets are to be valued for purposes of calculating the selling and repurchase prices of participatory interests. 6. Hedge fund requirements On 6 March 2015, the Registrar of Collective Investment Schemes issued Board Notice 52 of 2015, determining the requirements for hedge funds. These requirements were effective 1 April 2015 and a manager of an existing hedge fund had 12 months after registration as a manager to comply with the requirements. This notice distinguishes between qualified investor (QI) hedge funds and retail hedge funds. A QI hedge fund is a hedge fund in which only qualified investors may invest and a retail hedge fund is a hedge fund in which any investor may invest. A qualified investor is any person who: invests a minimum of R1 million a hedge fund has demonstrable knowledge and experience in financial and business matters (or who has appointed a financial services provider who has demonstrable knowledge and experience) to advise the investor regarding the merits and risks of a hedge fund investment. A manager of a qualified investor hedge fund does not have prescribed investment restrictions and, for this reason, may only invite or permit qualified investors to invest in the QI hedge fund. A QI hedge fund must, however, still adhere to the fund s liquidity requirements. 7. Disclosure requirements Hedge fund financial service providers were required, in terms of Board Notice 571 of 2008, to disclose the risks and other characteristics of hedge funds to clients. Although this board notice was issued before hedge funds were declared collective investment schemes, it remains applicable and hedge fund managers must continue to disclose the risks associated with hedge funds. Board Notice 52 of 2015 requires a manager to disclose and report certain information to investors to keep them informed and to potential investors to enable them to make informed decisions before they commit their money to an investment. Full disclosure on certain matters would provide investors with information to assist them in making an informed decision before they invest, and during the life of their investments. These matters include: investment strategy portfolio composition investment restrictions fund performance fees total expense ratios level of counterparty exposure liquidity risk management repurchase rights leverage levels Board Notice 92 of 2014 prescribes the advertising, marketing and information disclosure requirements for collective investment schemes. This board notice was issued before hedge funds were declared collective investment schemes and does not expressly deal with hedge fund-specific disclosures. A draft notice, which will repeal Board Notice 92 of 2014 once effective, was published earlier in 2017 and will prescribe certain mandatory and information disclosures applicable to hedge funds. 34

36 HOT TOPICS I OCTOBER Adjudicator A round-up of Pension Funds cases 35

37 ALEXANDER FORBES A round-up of Pension Funds Adjudicator cases Can the Adjudicator consider TCF when investigating cases? Du Toit (complainant) versus Central Retirement Annuity Fund (fund) and Sanlam Life Insurance Limited (administrator) The complainant was unhappy with the quantum of the causal event charges imposed on her by the administrator when she decided to transfer her fund value to another retirement annuity fund. The complainant joined the fund on 1 March 1995 with a contractual maturity date of 1 March The monthly contribution to the fund was initially R80.81 and it was subject to a yearly increase of 10%. The fund policy was subsequently converted to a newer generation plan and the monthly contributions increased to R1 000, subject to a yearly inflation increase. What caused the complainant s unhappiness? In February 2017, the complainant requested a quotation to transfer her fund value to the Allan Gray Retirement Annuity Fund. She was provided with a quotation which reflected that an early termination charge of R (11.82% of her fund value) would be levied on her total value of R The complainant contended that her fund value was drastically reduced due to high administration or termination fees. She was dissatisfied that an early termination charge of R was levied when she decided to transfer her funds to another fund. She indicated that she should have the freedom of choice to move her benefit to another fund that charges fewer administration fees. Causal event charges levied by the administrator The administrator confirmed that the fund policy contract, which had been given to the complainant, said that the administrator recovered charges from a member s fund value by cancelling units to the value of the fee when: a member took early retirement benefit reduced the recurring contributions stopped payment of the recurring contributions. These charges are called the causal event charges. The administrator said that most of the expenses it incurred happened when a member joined the fund or when contributions were increased. This cost was then recovered by means of charges which were levied over the term of fund membership. When the charges were calculated, it was assumed that the contributions would be paid up to the end of the policy term. If contributions or membership stopped before the end of the term, the administrator would not be able to recover these costs in the future. The administrator also showed the causal event charges were allowed by the fund rules and the Long-term Insurance Act and they fell within the quantum of charges allowed in legislation. The administrator further submitted that it subscribed to the principles of TCF. It submitted that the complainant was appropriately informed before, during and after the time of contracting. Did the adjudicator allow the administrator to levy the causal event charge? The complainant was provided with quotations illustrating the charge that would be imposed on early termination and she should have been aware of the effect on her fund value if she transferred to another fund. The adjudicator said that the causal event charges were lawful and the administrator could charge these. The complaint was dismissed. What did the adjudicator say about TCF? The adjudicator said that the actions of the fund and administrator were not anywhere near the letter and spirit of the TCF principles. The following TCF outcomes were applicable in this matter: customers are given clear information and are kept appropriately informed before, during and after the time of contracting customers do not face unreasonable post-sale barriers to change product or switch provider 36

38 HOT TOPICS I OCTOBER 2017 The respondents should actually refrain from quoting TCF principles when levying causal event charges as the charges are obscure and cannot be translated into value for members of retirement annuity funds. Though a settlement was reached, it does not in any way address the unfairness and absence of value that often accompany the levying of causal event charges. This tribunal has on countless occasions called for the implementation of the Retail Distribution Review. Although this will still not remove the obscure charges, it is at least a long overdue development that will ensure that entities like the respondents deliver on what their products promise. Thus, this tribunal is not satisfied that the levying of causal event charges in this matter is in accordance with the two TCF outcomes stated above. Section 37D of the PFA: When can a fund withhold payment of a benefit on the basis of a member s fraud, theft, dishonesty or misconduct? The PFA says that pension benefits cannot be reduced except for certain permitted deductions, such as: divorce orders maintenance orders tax any amount due by a member to their employer as compensation for any damage caused to the employer by reason of: any theft dishonesty fraud misconduct by the member and in respect of which the member has, in writing, admitted liability to the employer or judgment has been obtained against the member in court. 37