Edition: July / September 2016


On borrowed time

Pension funds’ portfolios are vulnerable should SA
lose its investment-grade status.

It’s in the manner of central bankers that they express themselves calmly. Leon Myburgh, head of the financial markets department at the SA Reserve Bank, did as much at the recent Batseta winter conference. But it didn’t soften his message that a downgrade of SA’s sovereign credit rating to junk status can hit pension funds hard.

That’s notwithstanding an important metric – the spread on credit default swaps – indicating that a downgrade has already been priced into investment markets. Nor does it indicate that the worst – the non-residents’ sell-off of R45bn in domestic equities and bonds during the fourth quarter of 2015, and a further R35bn of net outflows this year to end-May– is necessarily over.

Myburgh . . . SOE problem

The possible negative consequences of further rating downgrades, Myburgh warns, cannot be ignored. Given that investors require higher compensation for the higher risk associated with SA assets, particularly government bonds, yields will remain “elevated”. These higher yields will spill over to the bond and loan rates in the banking and corporate sectors, thereby increasing their costs of funding. In other words, even without the Bank tightening monetary policy, higher yields will increase the costs of doing business.

Pension funds, minimally holding cash, won’t be spared. Because they’re heavily exposed to bonds and equities, at 25% and 54% respectively for these asset classes, the spill-over effect on prices can be “significant” for the savings industry. Price volatility will have a large impact on portfolio valuation, Myburgh points out, and therefore “anticipation of future ratings actions need to be considered in asset allocation decisions given the potential for re-pricing these assets”.

There are consolations. Reflecting fiscal sustainability, to allow reasonably for the funding of new loans (about 40% of existing loans are owned by foreigners), the ratio of SA government debt to gdp is expected by the Bank to remain at 50%-51% (better than Brazil and India) over the medium term. Also, since only 10% of SA government debt is denominated in foreign currency, the exposure to exchange-rate shocks is reduced.

On the flip-side, however, contingent liabilities are excluded from the debt/gdp computation. These liabilities, mainly in the form of government guarantees to state-owned enterprises, are worrying. Better get Eskom and SA Airways right, or else.

The ratings agencies have given SA a breather, but only a breather, to put its house in order and show that economic growth can get underway. The message is stark.

FSB hits back

As this TT edition was going to press, the Financial Services Board filed its response to the allegations of Rosemary Hunter (see Cover Story). In it, FSB board chair Abel Sithole accuses Hunter of painting a picture that is partly also a dispute between her purportedly acting lawfully and FSB executive officer Dube Tshidi purportedly acting unlawfully.

“But her own affidavits show that she quarrels with everyone,” avers Sithole. “She always believes she is right and everyone else is wrong. She demonstrated her inability to accept good-faith differences in the course of the FSB discharging its functions as regulator, and she made herself guilty of insubordination by constantly challenging the authority and probity of her immediate superior. She makes many accusations against her colleagues and others, without proper substantiation, rendering their probability or even possibility open to significant doubt.”

Mort . . . report assessed

He deals extensively with the disputed “cancellations project”, arguing that the FSB had fully complied with its obligations, and cites in support a report from pensions lawyer Jonathan Mort who’d been engaged by the FSB to assess it.

Mort had found that, for a fund to cease to exist, it must have no assets and no liabilities. This would typically follow the assets having been transferred from the fund, in terms of s14 of the Pension Funds Act, with an accompanying extinction of the associated benefit liabilities. In May 2005 a comprehensive circular had set out the Registrar’s requirements for transfers.

These included a certificate by the valuator, principal officer or auditor of the fund confirming that it had no members, assets or liabilities. There were no requirements as to the information necessary for the Registrar to have been satisfied that a fund had ceased to exist.

Unless there was information to the contrary before the Registrar, said Mort, there would appear to be no reason why the Registrar couldn’t rely on the representations made in deciding whether to cancel a fund’s registration. He could also rely on the representations of any person such as an “authorised representative”.

According to Sithole, in deciding on the cancellations the Registrar did not rely on these representations alone. But for purposes of its report, KPMG had failed to take into account alternative proof that the Registrar had accepted. KPMG had only considered documents as at date of extraction of those documents from the FSB’s system. “They did not consider any documents uploaded to the system after the extraction date, despite Ms de Swardt (an FSB official) drawing KPMG’s attention to this shortcoming in March 2015,” says Sithole.

He adds that Jurgen Boyd (then the deputy registrar for pension funds) and De Swardt had assured him that they never had any reason to suspect that any applications for cancellation were made dishonestly or for improper motives: “Ms Hunter has also not advanced any evidence of such dishonesty or misconduct. That is a remarkable feat given the enormity of the cancellations project, which may properly be attributed to the safeguards built into the process”.

He asks that the court express its displeasure with Hunter’s “unsubstantiated and irresponsible allegations of dishonesty and bad faith” by ordering her to pay the FSB’s legal costs on the punitive attorney-client scale.

Confidentiality call

National Treasury might consider legislation which ensures that information, submitted in confidence to the Financial Services Board for it properly to perform its regulatory functions, remains in confidence.

This follows a letter to the FSB from Liberty chief executive Thabo Dloti: “In the normal course of our business we routinely receive requests for information from the FSB, to which we endeavour to respond comprehensively and in good faith. There is a risk that we cannot operate on the assumption that the information will be kept confidential or handled strictly in accordance with the purposes for which it was requested.”

Dloti . . . necessary

Dloti’s concerns arise from allegations, made by Rosemary Hunter in her litigation against the FSB, that have a direct reputational and commercial impact on Liberty. “Many of the disclosures made by (her) were neither appropriate nor in the public interest,” he wrote. “Much of the information was disclosed to (her) in the context of proactive engagement by Liberty Corporate in order to facilitate resolution of the issues that (she, in her capacity as FSB deputy executive officer) purports to raise for public consumption in the public interest.”

Such concerns have broad application. But legislation could be difficult to draft. It would have to draw a fine line between protecting FSB operations on the one side and, on the other, not impeding discovery processes in litigation or inhibiting the rights of whistleblowers under the Protected Disclosures Act. The new marketconduct authority will need to seek a solution.

Trustees’ pay

The whole governance regime of pension funds assumes that there are lots of competent people, or at least people keen to acquire the necessary competencies, taking on trusteeships. It’s an assumption that remains untested.

There’s much more to trustees’ role than adjudging beauty parades of asset managers. Given the time it takes properly to prepare for board meetings and attend them, to qualify in terms of skills sets now insisted upon, and to bear the fiduciary responsibilities that carry personal liability, it might be thought that an attraction is the remuneration. But this cannot be, as the fifth retirement-industry survey by accountancy firm PricewaterhouseCoopers reveals. The survey covers responses from a representative cross-section of 100 funds (excluding the GEPF) which together have R375bn in total assets.

Key findings of PwC are that on average:

  • The board has eight members;
  • Specialist funds have two professional board members;
  • As a proportion of total board members, 12% are professionals (25% for specialised and 7% for standalone funds);
  • Of the funds, 8% remunerated all board members while 47% remunerated some of them and 44% did not remunerate any;
  • Annual remuneration for board members is R79 254 for specialist funds and R63 028 for standalones.

Clearly, these pay levels pale against company directors holding similar responsibilities. It’s high time that the industry itself, if suitable trustees are to be attracted and committed, produces some benchmarks for appropriate remuneration. There’d be numerous variances, for instance in fund sizes and in skills attributes as well as considerations of whether trusteeship forms part of an employee’s day job. What of the argument that payment to trustees, by their funds, will reduce members’ benefits? One ready answer is that, to the extent of knowledgeable trustees being better equipped to monitor and negotiate fees of their service providers, the added expense of trustee remuneration could more than offset the dent in members’ benefits.

Either this or continue the plod in dreamland.

A kick in King

To be welcomed in the draft King IV governance code, distributed for comment, is its segmental focus on the retirement-fund industry. This supplement, integral to King IV, applies to all retirement funds. It also encourages them to follow the Code for Responsible Investing in SA (CRISA), a voluntary code that applies to institutional investors.

“King IV and CRISA are complementary, reinforcing one another,” Thuto Masasa of the Nkonki accountancy firm pointed out to the recent Batseta conference. “The supplement allows for certain terms used in King IV to be interchanged. For example, references to ‘organisation’ should be read as ‘retirement fund’ and ‘governing body’ as the ‘board of a fund’.”

The usual principles, of accountability and the like, are touched up in King IV. But unlike King, where “comply or explain” is a JSE listings requirement, CRISA is a voluntary code for institutional investors with no compliance obligations. Signatories are predominantly asset managers and, disappointingly, not retirement funds that should be leading the initiative.

It’s all the more reason, for the exercise to gain traction, that trustees familiarise themselves with King IV. They should be in the forefront of insisting on the highest corporate-governance standards not only of themselves but also of companies where their funds are invested.

Which highlights an area for them to debate about King IV. It’s whether, rather than a softlee-softlee approach to executive remuneration, SA shouldn’t move towards a binding shareholders’ vote.

Take your PIC

As deputy finance minister, Mcebesi Jonas chairs the Public Investment Corporation. It’s to his credit that the PIC is becoming more transparent about its unlisted assets, generally in a strategic statement of intent and recently to disclose for the first time (before a parliamentary portfolio committee) key details about its investment in Independent News & Media SA.

Jonas . . . open approach

It’s been a curious investment for a pension fund, given the predictably parlous state of the newspaper industry and specifically the declining circulations of INMSA’s metropolitan titles (TT April-June). But commercial viability seems less relevant than the wish of the PIC to help the creation of a black-owned Naspers, which is a great idea provided INMSA also finds something like a Tencent gaming operation in China and starts a rival to the Multichoice television services in SA.

Following the parliamentary disclosures, TT asked the PIC to elaborate. Spokesperson Sekgoela Sekgoela responded:

The PIC has noted with concern an increased effort by some in the media, certain members of parliament and some members of the public, to use incorrect and in some instances false information in an attempt to cast aspersions on its integrity and investment processes. The PIC invests al its clients’ money in accordance with mandates approved by the Financial Services Board. All investments are also subject to a rigorous investment process, including a thorough due diligence. The investment in INMSA was in accordance with the mandate and investment processes of the PIC.

What percentage of INMSA does the PIC own directly or indirectly i.e. the PIC’s present equity stake in INMSA?

Post the transaction the Government Employees Pension Fund, managed through the PIC, holds a 25% shareholding in INMSA.

Of the PIC’s R888m exposure to INMSA and the Sekunjalo Media Consortium, how much is in loans?

R722m of the R888m exposure is in loans. The GEPF’s investment into INMSA was accomplished through a typical private-equity leveraged buyout method where all the financial investor’s interests are protected above operational investors (e.g. management) who are expected to drive the value of the business. It is typical for interest in these structures, especially when funding black economic empowerment, to roll-up and be paid as a single payment at the end of the loan term. Interest will be serviced as and when cash is available during the interim period. These structures allow the company to invest in technology and expansion opportunities common in a takeover of this kind of asset.

The loans to INMSA and Sekunjalo are two years into their five-year term. Should the loans not be repaid, what is the investment risk to the PIC?

The answer to this question would be speculative.

Does the PIC hold sureties or other security from any Sekunjalo directors in respect of the loans?

The PIC holds various securities and sureties for the loans provided, including cession over 55% of the shareholding in the company.

In the event that the PIC loans are fully converted to equity, what percentage of INMSA will the PIC then own?

This question is theoretical and depends on various inputs.

Are there PIC-appointed directors on the board of INMSA and/or Sekunjalo? If not, why not?

The PIC does have representation on the INMSA board.

As they say in the newspaper industry, watch this space. Next thrilling encounters should be in the scrap between the Gupta family and Iqbal Survé of privatelyowned Sekunjalo, for a Gupta stake in INMSA, and for both their media houses to claim a greater share of government sponsorships in acknowledgment of ANC support.