This article looks at the purpose of Regulation 28 of the Pension Funds Act, as well as its Principles.
Why the need for investment regulation?
The aim of retirement fund investment regulation is to ensure that the savings South Africans contribute towards their retirement is invested in a prudent manner that not only protects the retirement fund member, but is channelled in ways to achieve economic development and growth.
To achieve this, rules governing retirement fund investment should allow for inflation-beating capital growth for younger members and inflation-matching income for older and retired members. This can be reflected through the right mix of low risk-return “safe” assets with higher risk-return innovative products. The rules should likewise strike a balance between regulatory paternalism and empowering those entrusted with the management of retirement fund assets to do due diligence and make decisions of what investments are most appropriate for their fund’s particular liability and liquidity profile.
Fiduciary duties and the importance of the Investment Policy Statement
An important consideration is the level of expertise on boards of trustees and their ability not only to make investment decisions, but also to delegate certain tasks (but never their ultimate responsibility) to advisers like asset managers, asset consultants and risk consultants. To the extent that trustees are inadequately informed of investment and liquidity requirements, governance, and risk management, the regulation provides strong direction through rules rather than guiding principles.
Regulation 28 is both rules-based and principles-based
Regulation 28 is primarily rules-based. However, principles were also introduced to strengthen the investment decision-making processes and improve the transparency and accountability by retirement funds to a retirement fund’s members and the Registrar of Pension Funds at the FSCA (Financial Sector Conduct Authority). In effect, these principles – as captured through an Investment Policy Statement (IPS) – should inform a fund’s investment approach related to the aspects identified in the regulation.
Regulation 28 principles include:
- Promoting relevant trustee education;
- Monitoring compliance by the fund and its agents;
- Ensuring asset/liability matching by the fund;
- Performing appropriate due diligence on investments, making sure not to rely wholly on credit rating agencies for assessing credit risk;
- Taking into account the long-term sustainability of investments, in particular considering the impact of environmental, social and governance (ESG) aspects;
- The IPS should also contain other details relevant to investment policy, including, for example, asset mix and rate-of-return calculations.
A fund may only invest in assets specified in the regulation and within the issuer and aggregate limits defined. Provision is, however, made for involuntary breaches that fall beyond the control of the board, brought about for example by market movements or corporate actions.
Investing in the best interests of the fund and its members
In making investment decisions, a retirement fund should be guided first and foremost by what is best for the fund and its members, and should invest accordingly; indeed, what is enabled through the Regulation 28 limits may not be in the best interest of each and every fund or member. On the other hand, asset limits imposed should not prevent a fund from achieving its optimal investment allocation. Where funds begin to meet limits and think it prudent to exceed them, in such instances the board should engage the registrar on possible exemption. The National Treasury has in some instances taken a more conservative view on the limits in Regulation 28 with the idea that these can (and should where appropriate) be tested by market participants in the future.
Regulation 28 compliance at both fund and member level
Mindful that individual member protection is as important as ensuring the sustainability of the fund as a whole, retirement products should be compliant not only at a fund level, but also at member level. Significantly tighter limits apply to unregulated and unlisted products, relative to those that are regulated and/or listed. In addition to the category and issuer limits that are identified, overarching limits are applied to unlisted and alternative assets.
The regulation does not prescribe what assets a fund should be invested in as this would counter the principles guiding the fund to act in its best interests. Instead, as explained, the regulation requires a fund to explicitly consider its approach to ESG issues (with respect to its investments) and transformation (with respect to services provided to a fund). Moreover, economic development is more strongly supported by increased flexibility afforded to investment into private equity funds and public debt.
Regulation 28 Principles
2 (a) A fund must all at times comply with the limits as set out in this regulation.
b) A fund must have an investment policy statement which must be reviewed at least annually.
c) A fund and its board must at all times apply the following principles:
(i) promote the education of the board with respect to pension fund investment, governance and other related matters;
(ii) monitor compliance with this regulation by its advisers and service providers;
(iii) in contracting services to the fund or its board, consider the need to promote broad-based black economic empowerment of those providing services;
(iv) ensure that the fund’s assets are appropriate for its liabilities;
(v) before making a contractual commitment to invest in a third-party managed asset or investing in an asset, perform reasonable due diligence taking into account risks relevant to the investment, including but not limited to, credit, market and liquidity risks, as well as operational risk for assets not listed on an exchange;
(vi) in addition to (v), before making a contractual commitment to invest in a third party managed foreign asset or investing in a foreign asset, perform reasonable due diligence taking into account risks relevant to a foreign asset including but not limited to currency and country risks;
(vii) in performing the due diligence referred to in (v) and (vi), a fund may take credit ratings into account, but such credit ratings should not be relied upon in isolation for risk assessment or analysis of an asset, should not be to the exclusion of a fund’s own due diligence, and the use of such credit ratings shall in no way relieve a fund of its obligation to comply with all the principles set out in paragraph 2(c);
(viii) understand the changing risk profile of assets of the fund over time, taking into account comprehensive risk analysis, including but not limited to credit, market, liquidity and operational risk, and currency, geographic and sovereign risk of foreign assets; and
(ix) before making an investment and while invested in an asset consider any factor which may materially affect the sustainable long-term performance of the asset including, but not limited to, those of an environmental, social and governance character.
(d) With the appointment of third parties to perform functions which are required to be performed in order to comply with the principles in (c) above, the fund retains the responsibility for compliance with such principles.