The revised amendments to Regulation 28 of the Pension Funds Act are likely going to be more onerous for the industry to comply with. Trustees need to ensure that they are fully aware and ready to face and solve these hurdles, according to PwC.
Regulation 28 of the Pension Funds Act of 1956, which limits the extent to which retirement funds can invest in specific asset categories, has undergone a rigorous process which began quite some time ago. The wait is finally over. The revised version of Regulation 28 has been released and will be applicable to all retirement funds from January 2012.
The revisions were made to reduce risks and enhance protection by members, closing some obvious loopholes and to ensure that all investment vehicles were accommodated. However, the following revised amendments may be a bit more burdensome when complying with the changes to legislation:
· The limits per investment type and or asset category must be adhered to throughout the reporting period. This will place an additional burden on the trustees of the fund, the administrators who will have to monitor this and the auditors of the retirement fund who will have to provide assurance opinions on the Regulation 28 reports. In addition, it’s likely that asset managers will have to adjust their reporting structures as they also have to monitor this;
· The investment limits will not only apply on a fund level, but also on a member level where they need to be monitored. As from 1 March 2011, these limits apply to the individual member portfolios when a member elects an investment choice on the date that the investment option is elected. This will become an extensive exercise for funds with large member numbers and those with individual member investment choice. However, an exception is made for certain existing individual contractual arrangements to include retirement annuity, pension preservation and provident preservation funds that were in place before 1 April 2011. These products will be allowed to remain outside of Regulation 28 limits until such a time that any material contractual provisions related to those arrangements are changed;
· Alternative types of investments were previously limited to 2.5%. With the revised Regulation 28, funds are allowed to invest up to a maximum of 10% in hedge funds and to a maximum of 10% in private-equity funds. However, a fund should not invest in such vehicles if the potential loss to the fund is in excess of the funds investment in such assets. The fund’s trustees and decision makers need to ensure that investment mandates are updated to take cognisance of the above requirement.
· Provision is now made in the revised Regulation 28 so that “the limits may be exceeded where the excess is due to an increase or decrease in the fair value of investments because of, amongst others, market movements, non-optional corporate actions and changes in the market capitalisation of a security that is listed on an exchange”. Trustees will need to make sure that any deviations from the limits prescribed are monitored and followed up to confirm that the underlying assets of the fund are still in compliance with the requirements. In addition, trustees should be careful of further investments into investment types and or asset categories that already exceed the respective limits.
· Funds are also allowed to engage in security-lending transactions, subject to specific provisions and conditions as prescribed by the Regulator. Responsibility is placed on the trustees to ensure that they have an appropriate understanding of the securities-lending transactions entered into by the fund and that it is monitored on a continuous basis. Trustees must also review the funds security-lending policies on an annual basis as per the criteria of the provisions and conditions.
· Funds can also invest in derivate instruments, which again are subject to specific provisions and conditions as prescribed by the Regulator. Through these provisions and conditions, it is clear that trustees of funds must have a clear understanding of the derivative instruments invested into by the fund, as well as the composition of the underlying assets in these investment products.
· The revised Regulation 28 also introduces a definition of the “look-through principle” to deal with the challenge of not seeing the real economic exposure of certain assets to fund. It is imperative that all stakeholders in the industry understand when this principle should be applied and to which assets it must apply, so that a fund can be compliant. A 5% de minimus rule was also introduced to assist funds in mitigating undue regulatory burden and alleviate extensive disclosure requirements.
As such, trustees need to be responsible in line with good governance for retirement funds and need to be prudent when it comes to the investment of funds’ assets.
An overriding preamble of the revised Regulation 28 is the fiduciary responsibility of a retirement fund’s board to invest members’ savings in a way that promotes the long-term sustainability of the asset values. This takes into account environmental, social and governance (“ESG”) issues. One criticism of the current Regulation 28 was that it was entirely rules based, so the introduction of principles is seen as a step in the right direction.
The principles introduced strengthen the investment decision making processes and improve the transparency and accountability of the board to a fund’s members and the Registrar. These principles are captured in an Investment Policy Statement (IPS) and 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 offerings, making sure there isn’t an entire reliance on credit rating agencies for assessing credit risk.
- Taking into account the long-term sustainability of investments, in particular considering the impact of ESG aspects.
These principles, together with the preamble, give better guidance to trustees to consider what investment strategy would be appropriate for the specific nature of their fund. However, the perceived general lack of investment expertise amongst Boards of trustees means the revised Regulation 28 primarily remains rules-based.
The definitions pertaining to the different investment types and asset categories have been made much clearer than the current Regulation 28. “The purpose of refining the definitions in the revised version is to mitigate the risk of regulatory avoidance. This further supports the governing limits and takes into account the changing investment landscape.
In this light, there are alternative investments like derivatives, hedge funds and private-equity funds that are explicitly defined and referenced in the revised Regulation 28. Other references have been updated to reflect changes in relevant governing legislation.
As with the current Regulation 28, the different percentage allowances (“rules”) per investment type and/or asset category are also stipulated in the revised Regulation 28. These will assist the trustees and other stakeholders to have a clearer understanding of the type of assets per category as well as the allowable percentage per category.
There are still a number of industry uncertainties regarding to the practical implementation of the revised Regulation 28. Therefore, trustees of funds need to ensure they have the proper understanding of the types of investments held within a fund and that the investment policy of the fund adheres to the requirements.