The Final Version of Revised Regulation 28 in a Nutshell

Background

Revised Regulation 28 represents a radical shift from its predecessor. Rather than determining prudential investment limits, it now lays down general investment principles. This revised Regulation 28 was drafted in consultation with affected
stakeholders.

The second draft of revised Regulation 28 was issued in December 2010. The final version of revised Regulation 28 was published as an annexure to the 2011 Budget speech. It will be effective from 1 July 2011.

National Treasury and the FSB are to hold stakeholder workshops to provide guidance on the treatment of securities lending, derivatives and part guaranteed insurance policies during March 2011. These two bodies will also draft Notices and
Guidance Notes on hedge funds and private equity valuations as well as on the above issues. These will be published for comment before the revised Regulation 28 is finalised in March 2011.

Extensions

Funds who will not be able meet the implementation deadline, should apply for exemption to the FSB before 31 May 2011. Trustees should discuss this with their consultants and investment managers.

Exemptions

On application, the FSB may exempt Funds from some or all of the provisions.

Principles

Funds must comply with the limits set out in the revised Regulation 28. They must also have a formal Investment Policy Statement (IPS). In practice, most funds already comply with this as it is a requirement of PF130. Some of the key principles to be applied by the fund and its board:

• Promote the education of trustees in respect of governance, investments and realted matters
• Take a responsible investment approach that will earn adequate risk-adjusted returns suitable for the funds’ specific member profile, liquidity needs and liabilities. (This effectively makes Annexure B to PF130 law.)
• Ensure the funds’ assets are appropriate for its liabilities. For a defined contribution fund, this involves considering the effect of a long term investment strategy on members’ expected retirement benefits.
• Carefully consider the default option in place for members, which will transition the affected members into less risky assets closer to retirement
• Ensure that in the event of individual member choice, each portfolio offered complies with the regulations
• Understand the nature of the assets in which the fund invests. To this end, they must conduct reasonable due diligence before making contractual commitments to invest in assets managed by a third party for both local and foreign assets They must also understand the changing risk profile of assets over time, as well as the need to consider environmental, social and governance characteristics
• Promote broad-based black economic empowerment of service providers to the fund.

Asset limits: general rules

• Foreign exposure limits will fall in line with current exchange control regulations. Any breach need not be remedied if it was due to market movements (this is up to the FSB, but funds generally have 12 months to correct this position). However, no new investments may be made into assets that are in breach.
• Hedge funds and private equity funds are now explicitly allowed, subject to certain restrictions and conditions. Up to 5% can now be allocated to fund of hedge funds, 2.5% to an individual hedge fund and 10% to hedge funds in total.
  In other words, a higher amount can be allocated to fund of hedge funds than to individual hedge funds directly
• The “look through” principle is introduced, where an asset holds underlying assets. Historically funds could hide the nature of an investment behind structures such as wrap funds and debentures. The look through principle now applies Regulation 28 limits to all investments.
• There are however some exceptions, including hedge funds, private equity funds, and holdings below 5% with different kinds of assets (only the main asset type will apply). The definitions of equity, cash and immovable property are
  defined narrowly in “table 1 of the revised Regulation (“prudential guidelines”). If investments do not fall into these narrow definitions and are specifically excluded, they will be considered broadly as debt and subject to the look through principle
• The following investments could potentially be excluded from the look through principle on reporting, subject to specific conditions being met. These are:
• Collective investment schemes (ie unit trusts)
• Linked policies
• Long term policies with guarantees or partially guaranteed policy benefits. This will be clarified in the guidance notes expected in March 2011
• There are further restrictions on asset combinations relating to unlisted investments. The aggregate exposure to unlisted investments must not exceed 35 percent of the aggregate fair value of the total assets of a fund. Further, the aggregate cash and debt exposure by a fund to an issuer or entity must not exceed 25 percent of the aggregate fair value of the total assets of the fund.
• Securities lending and derivatives are explicitly allowed, subject to certain restrictions and conditions. Each has its own annexure. The annexure on derivatives covers both the use of derivatives (what is allowed and what is not) and the monitoring / reporting on this type of investment. As stated previously, guidance notes are expected in March 2011
• Tighter limits apply to unregulated and unlisted products for smaller assets in comparison to similar assets which are regulated and listed and which have larger market capitalisation values.
• Commodities are recognised as a separate asset class and are limited to 10% of total fund investments. Within this, there are further restrictions: the entire 10% commodity limit can be invested in gold, whereas all other commodities are limited to 5% per commodity
• Retirement funds may only borrow bridging finance, limited to 50% of gross income that can be earned. This needs to be paid back within 12 months.

The table that follows outlines a summary of the main features of the adjusted rules applying to Regulation 28

Market Capitalisation (market cap)
This is the value attributed to a company by multiplying the number of issued shares by the market price

Category	Limit	Sub Limits
EQUITIES	75%
No more than 15% in an equity where the market cap is in excess of R20bn		15%
No more than 10% in an equity where the market cap is between R2bn and R20bn		10%
No more than 5% in an equity with a market cap of less than R2bn		5%
Limit for unlisted equities Subject to strict valuation requirements		15%
Foreign exposure including inward listed shares		25%
Investment in a suitably regulated vehicle in Africa		5%
CASH No more than 25% in a single Money Market instrument issued by a South African bank	100%
DEBT The limit for (on-balance sheet) bank issued corporate and public debt is raised to 75%	100%
PROPERTY A fund may have up to 25% in listed property similar to equities listed property is divided in to 3 sub-categories	25%
A market cap greater than R10bn		15%
A market cap between R3bn – R10bn		10%
A market cap less than R3bn		5%
COMMODITIES A fund can invest in listed commodities up to 10% in gold or up to 5% in any other commodities	10%
HEDGE FUNDS AND PRIVATE EQUITY Fund of hedge funds and fund of private equity funds, 5% per fund or 2.5% per hedge fund or private equity fund.	15%
Other assets not referred to in the amendment	2.5%
HOUSING LOANS Loans granted to members directly by the fund Loans granted to members where the fund stands as surety can take place normally as per the regulations	95%