Should legislation or regulation relating to the introduction of prescribed assets be formally tabled by the South African government, such assets need to be structured as attractive investment opportunities in order to encourage domestic and international investment into the full spectrum of infrastructure assets in South Africa.
What are prescribed assets?
The term “prescribed assets” refers to a government policy that requires investors, like retirement funds, to hold a certain amount of investments in government-specified assets, such as government or state-owned entities’ (SOEs’) bonds. These assets could be issued by SOEs, through standalone projects, such as a highway, power plant or other specific public infrastructure initiative, or by the government directly for “general purposes”, such as funding transport or water infrastructure.
The discussion around prescribed assets arose in the ANC’s 2019 election manifesto, which proposed to “investigate the introduction of prescribed assets on financial institution funds within a regulatory framework for socially productive investments (including housing, infrastructure for social and economic development and township and village economy) and job creation while considering the risk profiles of the affected entities”. However, it has not yet been officially tabled as part of any draft legislation or regulation, hence there is very little detail around what form it would take.
Prescription is not new
Under the apartheid government, pension funds, life insurance companies and the Public Investment Corporation (PIC, the manager of the Government Employees Pension Fund) were
required to invest from 33% to 75% of their assets in government, government-guaranteed and specified government-approved bonds, resulting in large distortions in the local bond market. These prescriptions originally served as prudential guidelines (equivalent to today’s Regulation 28). However, the Jacobs Committee of 1988, established to investigate these inefficiencies, found that prescribed investments eventually came to be regarded as an “assured source of public funding” for government projects.
As a consequence of this assured public funding, South Africa saw the development of a dual market; a lack of trading in bonds, as investors wanted to hold them to maturity; a lack of transparent pricing; underpricing of risk; and, most importantly for investors, the underperformance of investment returns from these prescribed assets. Simply put, investors did not receive adequate returns for the investment risk they had to assume as a result of prescription.
The Jacobs Committee furthermore found that because investors were forced to invest in prescribed assets rather than better-performing equities – and by holding more bonds than would likely have been appropriate for their risk profiles – investors received a real return of 8.6% less than they should have in the 1970s, and 2.9% less than they should have in the 1980s. This was a significant opportunity cost to investors, which ultimately led to individual retirement fund members receiving reduced pensions. In the face of these negative impacts, the Jacobs Committee recommended the abolition of prescribed assets, which was implemented in the 1989 National Budget.
Criticisms of prescription
The primary concern regarding prescription is that it leads to South Africa’s savings (insurance and retirement fund assets collectively representing R6.2tr per ASISA figures) becoming an instrument of state policy, and so avoids the investment discipline of financial markets and the fiduciary responsibility of trustees and their appointed asset managers, in turn resulting in lower-than-market returns for investors. The criticisms of prescription are outlined below:
- Prescription will likely result in investors being forced to invest in SOEs, such as Eskom, Transnet, SAA, the Land Bank etc., where poor governance, mismanagement and lack of delivery have been rife, further compounded by state capture in recent years.
- Retirement fund members are the ultimate owners of investment capital managed by fund managers. Retirement fund trustees entrust the responsible management of their investments to professional fund managers, who need to make investment decisions in the best interest of their clients. Prescription is at odds with the fiduciary duty of those entrusted with the responsible management of other people’s savings.
- Dictating how investors should invest interferes with the capital allocation function of capital markets, which should always be objective and driven by performance. By forcing the market, through prescription, to invest in assets producing lower-than-traditional market returns and/or forced investment in high-risk assets removes the competition for funding and the performance incentive, as well as depriving more deserving projects from much-needed finance.
- Forcing investors to invest into specific assets pushes up the price, or pulls down the yield, resulting in artificially low interest rates. This, in turn, pushes them down to below inflation rates, resulting in negative real returns for investors. This results in ‘cheap money’, which distorts the asset allocation process and further causes higher rates of inflation.
- Freedom of choice is a basic tenet that all South African citizens enjoy, whether it be as citizens, customers or investors. This includes the ability for investors to freely change their investments to adapt to changing market conditions and investment goals.
- Prescription will also have a negative impact on the country’s credit rating, which would see foreign investors – many of whom are pension funds – being forced to withdraw their investments from South Africa.
Investing in South Africa’s future
In order to attract domestic and international investors into the full spectrum of infrastructure assets in South Africa, such assets need to be structured as attractive investment opportunities, providing revenue streams and risk-return profiles that match investors’ return expectations and liability structures. Government has the responsibility to introduce mechanisms to support private capital funding of public assets, changing the risk allocation between the private sector, taxpayer and consumer.
Bonds, for example, are an inevitable asset class for retirement funds, especially if the funds practise asset and risk diversification and require stable income. Retirement funds are already significant investors in government or SOE-issued bonds. Prescription therefore does not seem to be of absolute necessity, and even if it were to be necessary, it seems to result in unintended consequences that will do more harm than good. Over the past 20 years, retirement funds have, on average, held about 20% of their total assets in government and SOE bonds. For the right product and price, there should always be a buyer or investor, and current South African government bonds yield good returns compared with other foreign sovereign bonds. Financial institutions have also indirectly participated in funding public sector spending through their purchases of South African government and SOE bonds, valued at some R1.3tr.
Example: SA’s Renewable Energy Independent Power Procurement Programme
Due to the right incentives and policy environment being in place, one example of investor support for investing in infrastructure assets in South Africa over the last ten years – without the necessity of prescription – is the financing and construction of South Africa’s Renewable Energy Independent Power Procurement Programme (REIPPP). The REIPPP was able to achieve both economic and social impact – over and above the provision of additional power capacity through renewable energy projects, such as solar and wind energy projects.
ASISA | OECD | Prudential Investment Managers | FSCA
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