Trustee investment responsibility and regulation

We have recently seen increased monitoring and surveillance of retirement fund investments by the regulatory authorities, the Financial Sector Conduct Authority (FSCA – formerly, the FSB) and the South African Reserve Bank (SARB).

There was a quick reaction on the part of the FSB to gather information on retirement funds’ exposure to the Steinhoff corporate failure. Late in March 2018, the then FSB published a draft Directive on Sustainability Reporting and Disclosure Requirements. In addition, the current FSCA plans to issue a directive to make compliance with the retirement fund supplement in the King IV report compulsory.

Olano Makhubela, Acting Commissioner at the FSCA, recently said that we have Regulation 28 to thank for the fact that despite the average exposure of funds below 6%, the R180 billion loss in Steinhoff only translated into a 1% reduction of total assets in retirement funds. In the African Bank collapse the position was very similar. It is true that Regulation 28 does encourage diversification but at the same time, if the maximum exposure according to the regulation was taken up by any fund, such exposure to Steinhoff could have been 15% of the market value of the retirement fund or, expressed differently, 20% of the equity exposure. The jury is still out on whether or not Regulation 28 is really effective in these circumstances. In the examples stated, it was not Regulation 28 that limited the exposure, it was the fund managers and market itself.

An example where retirement funds were tested and (at least for a period) failed to apply their own minimum diversification rules, was the Naspers exposure in the benchmark equity indices. Many passive funds were forced to have an approximate 15% exposure to Naspers and some active asset managers by choice maintained full exposure. The investment has paid off for some time now. Many asset managers have, however, reduced their exposure to Naspers as they clearly do not consider it wise for a retirement fund to pin so much of its return on just one share.

Regulation on collective investment schemes in offshore jurisdictions like the US imposes further reporting requirements as soon as a fund holds more than 10% of its fair value in a counter. It appears that, in practice, offshore fund managers often regard a holding of 5% of fair value as expressing a very strong view on a share. The South African regulatory standard is therefore almost three times the limit considered prudent by many offshore managers. It is probably a function of the concentrated nature of the South African market.

Against this background, it is encouraging that the South African Reserve Bank (SARB) increased the potential offshore exposure of retirement funds to 30% of fair value and a further 10% into investments in Africa. This will conceptually allow for better diversification of investment portfolios. However, increasing potential offshore exposure is not as clear cut as it would seem, as some retirement funds may be mature with significant cash flow and rand based liabilities. Coupled with a low and an increasing interest rate environment in developed markets, careful consideration of liabilities and matching of assets will be required from boards of retirement funds.

The preamble of Regulation 28 states that boards have a fiduciary duty to act in the best interests of its members, whose benefits depend on the responsible management of the fund’s assets. In our view, the regulation is slowly moving to a prudent management approach rather than a strict compliance approach, and there should be less reliance by boards on the prudential guidelines of Regulation 28 in determining their investment strategy. It is therefore more and more important that each fund consider its own liability structure, liquidity requirements and its members’ expectations in determining its investment strategy. The regulation already allows significant investment freedom and abiding by the limits of the regulation may not in itself be sufficiently prudent for a retirement fund.

Dirk Oosthuizen
Head: Research, Development and Implementation