Regulation 28Study Notes

Objectives

• to protect investors of retirement funds from– Effects of poorly diversified portfolios– Over exposure to higher-risk asset types

• Ensure that retirement contributions are invested in a prudent manner– Protecting investor– Channelling economic development and growth

• Insurance policy assets must meet Reg 28 requirements

DEFINITION

A hedge fund is an asset which uses any strategy or takes a position that could result in the portfolio incurring losses greater than its fair value at any point in time and which strategies or positions include but are not limited to leverage and net short positions

• Managed by a licensed hedge fund Financial Services Provider

• Subject to any prescribed conditions

background

• Many amendments since inception in 1998• Reasons for amendments– Inconsistencies in the regulations eg definitions– Loopholes which allowed retirement funds to avoid

regulatory rules– Ability for retirement funds to invest in assets

exposing them to unacceptable risk levels– Credit risk issues– No provision for Islamic compliant retirement funds

Current regulation

• Prescribes maxima for certain types of investments

• No restrictions bank-issued money markets and government bonds

• No guidance on use of derivatives• Registrar may exempt funds from certain

maxima

process

• Public consultation• Key issues brought up– False mordenisation of market– Limit on debt too strict– Restrictions on alternative investments may hinder

economic growth– Investments in Africa may promote development of

South Africa • After feedback amendments made to the current

regulation

amendments

• Greater accountability for trustees• Sturdier markets for corporate debts• Greater protection of investors• Greater use of alternative investments• Expansion into foreign markets done

responsibly

Explanation of new regulation

• Refining of definitions to mitigate risk of avoiding regulation

• Tighter definitions to reflect risk-return profile of investments

• References updated to reflect changes in exchange environment

Preamble and principles

• Preamble frames regulation• Retirement fund board must invest savings in a

manner that – promotes long term sustainability of asset values– takes into account environment, social and governance

issues• Better guidance to trustees investment strategy• Recognise that a too conservative approach can be

damaging to long term savings in the same way a too risky approach is

Preamble and principles

• Strengthen investment process• Improve transparency• Improved accountability of trustees to the

Registrar• Principles captured in Investment Policy

Statement (IPS)

Investment policy statement

• Inform a fund’s investment approach on aspects identified in the regulation including:– Promoting relevant education of trustees– Monitoring compliance of the fund and its agents– Asset-liability matching– Performing appropriate due diligence on investments

– not relying heavily on credit-ratings from credit rating agencies

– Long term sustainability of fund– Any other relevant details

Asset limits

• Investments done within the limits of the regulation• Provisions made for breaches beyond the control of

the board• Board should make investment decisions based on

what is best for the fund and its investors• Asset limits should not prevent fund from reaching

optimal investment• Board may apply for a breach of limit from the

Registrar

Asset limits

• Mindful of the importance of individual member protection and fund sustainability

• Exceptions for certain existing individual contract arrangements

• Allowance outside Reg 28 until such a time they may be changed

• Some asset definitions are narrow• Anything outside definitions may fall under debt• Exceptions – hedge funds

- private equity - alternative investments

cash

• Instruments collectively used for liquidity management

• Includes money market instruments• Concern over maturity transformation in

money market funds• Strengthening needed to protect investors and

safeguard against future financial instability

Debt instruments

• Improved diversification• Reduce regulatory induced distortions• Better support to corporate debt instruments• Lack of transparency leading to information

asymmetry between investor and issuer• Aggregate limit for debt raised to 75%• Stricter limits across issuer sub-categories for

unlisted debt instruments• Credit ratings may be used for broad due diligence

Equities

• Asset class• Include preference and ordinary shares only• Aggregate limit of 75%• Limits on issuer sub-categories• Limits checked for inflationary pressures and

updated accordingly• Limit on unlisted equity 15% subject to

diversification and valuation requirements

Immovable property

• Unlisted property may have significant risk management implications

• Limits on exposure• Limits on sub-categories as well• Limits checked and tested by Registrar over

time and updated accordingly• Debt instruments backed by property listed as

debt

commodities

• Have hedging potential• Fund can invest in listed commodities– Max 10% gold– Max 5% other commodities– Combined maximum of all commodities of 10%

Other assets and alternative investments

• Hedge funds and private equity defined• Prevents these products from being reported as the

linking structure• Guidance to investments activities• Hedge fund defined as such and no other products

hiding under hedge fund disguise• Accessing hedge funds and private through funds of

funds providing extra layer of due diligence and diversification

• Registrar impose extra requirements

Foreign assets and regional development

• Foreign assets currently defined• Recognised foreign exchange falls away• To be considered as listed an exchange must be listed on an

exchange that is a full member World Federation of Exchanges

• Allows exposure of retirement funds to foreign assets through a suitably regulated vehicle

• Inward or dual listed securities on an SA exchange treated as listed

• Subject to limits - 75% equities – 50% dent• Foreign markets have access to South African capital

Look through

• Use of hedge funds as loophole to hold risky assets in the past

• Funds may not use asset structure to avoid asset limits

• Disclose underlying assets• Exceptions are private equity and hedge funds• Definitions ensure that look-through is not abused• De minimis rule applied to lessen far-reaching

disclosure requirements

borrowing

• Funds may never borrow funds for purposes of investing borrowed funds

• Only allowed to borrow when acing liquidity problems in paying members leaving the fund

• Limit on the amount borrowed and time constraint

• Stay away from exploitative arrangements and inappropriate loan terms

Reporting, exclusions and exemptions

• Not all funds used in calculation of percentage limits• An FSB regulated entity offering a Reg 28 compliant

product excluded from limit calculations• Funds may apply for exemption for a given time

and certain limits• Funds should act in best interests of stakeholders

which may be in conflict with Reg 28• Funds may engage Registrar and apply for

exemption based on these grounds

implemantation

• Effective from 1 july 2011• Contracts before 1 April 2011 exempt• No contracts that are not Reg 2 compliant may

be sold• Warning against exploiting the exempt

contracts

Conclusion

• Reg 28 now rigorous, flexible and fair• Suitable to the South African context• Challenges may arise in implementation and

funds may engage the Registrar in this regard