March 23, 2020

The good and bad of prescribed assets

Some retirement fund members are confused and concerned following speculation in the press about prescribed assets, which would require retirement funds to invest in failing state-owned enterprises (SOEs) such as Eskom and South African Airways (SAA) (the latter is currently under business rescue).

Some people in society argue that using prescribed assets is a good concept, as it will harness the nation’s savings to rebuild Eskom and SAA for our collective good and to the benefit of future generations.

Others argue that prescribed assets is a horrible idea, as it will only temporarily prop up SOEs that are failing because of corruption and mismanagement. The argument continues that further investment is folly, as it feeds the corruption and malfeasance that is still in place.

It is equally important to understand that the failure (to date) to hold those accused of corruption and mismanagement at SOEs accountable lends support to those against coerced investment in SOEs such as Eskom and SAA. The National Prosecution Authority announced that between seven and nine years are required for such prosecutions. South Africa cannot wait this long to repair the damage done in the lost decade.

Regardless of whom one chooses to believe, two issues remain for consideration:

  1. Job losses will be difficult to avoid as both Eskom and SAA are overstaffed and need to reduce their respective headcounts. According to reports, Eskom needs to reduce its staff by approximately 13 000 and SAA by approximately 2 300.
  2. Retirement funds are keen to invest in (electricity) projects where they can earn a fair return, where projects are well managed, where management is held accountable and, crucually, where there is no corruption.

Does Eskom need our retirement savings to avoid rolling blackouts?

It is possible to avoid further rolling blackouts.

In December 2019, the President of South Africa announced a range of measures which would make it easier for private sector projects to supply energy to the national grid. To date, we have not seen any evidence of the implementation of the President’s announcements by the inter-ministerial committee on energy (“Energy War Room”) that is chaired by the Deputy President, nor any evidence of the implementation from the Minister of Energy.

Furthermore, the expected bid window 5 for independent energy producers also appears to be delayed.

There is enough capital available for the private sector to fund improvements to South Africa’s electricity woes. Importantly, the stomach to fund Eskom is not there, unless significant changes are made to address the current downward spiral.

The concerns about Eskom are about the legacy of long-term mismanagement, about evidence of past corruption, about a technical skills shortage and about the overstaffed bureaucracy that runs Eskom.

It is not difficult to conclude that South Africa’s electricity crisis can be addressed without having to resort to coerced investment or prescribed assets.

Prescribed assets

Prescribed assets does not mean that our retirement savings will be expropriated, nationalised or taken away from us. It means that Government and the Regulator can change the rules so that retirement funds are required to invest in certain types of investments, e.g. bonds and money market instruments. It distorts the capital allocation process, which means that the return on investment will be distorted (lower).

Should prescribed assets be considered (in a way similar to before it was abolished in 1989), South African retirement funds would be required to invest more of their assets in government bonds, government guaranteed bonds and the money market. Even worse, is a shareholding in an SOE (e.g. some asset managers have shares in ACSA). These SOEs have shown a substantial disrespect for minority shareholders. The end-result could well be a lower return for retirement fund members (otherwise, there would not have been a discussion about prescribed assets in the first place).

The impact of lower investment returns for retirement fund members would be to reduce the amount of capital accumulated by individual members on retirement. The impact on young members would be more significant than on those closer to retirement, as younger members would suffer compounding of lower investment returns over a longer period (even if the prescription ends up being applied only for a short period).

If prescribed assets are introduced, is membership of a retirement fund a bad idea?

  • Despite the potentially lower investment returns that could result from prescribed assets, retirement funds remain a very cheap and efficient way to save for retirement.
  • It is not advisable for members to cash in their retirement savings by way of resignation or early retirement.
  • The tax payable on resignation or early retirement remains significant.
  • One should also keep in mind that contributions to retirement funds are made with pre-tax money.
  • Retirement funds do not pay tax on investment returns or capital gains.
  • Retirement benefits are exempts from estate duty.

Should Government at some point consider prescribed assets, the most feasible advice to members would be the same as when driving on a slippery road – to steer into the slide. This can be achieved by saving more (either in a retirement fund or with after-tax money in tax-free vehicles).

What other options does Government have to encourage investment into the economy and to create jobs?

  • Increasing competition.
  • Reducing regulation.
  • Privatising non-core SOEs.
  • Improving municipal and provincial services:
    • Laying out of new townships.
    • Improving inner-city conditions.
    • Improving security.
  • Support of small businesses etc.

We believe that Government has many options to improve delivery in terms of the social compact, rather than to resort to prescribed assets.As with so many things (e.g. climate change), the younger generation will be required to pay for the sins of their elders.