Issue: March 2012 / May 2012
Warts and all
When the intention of prudential-investment guidelines appears to be intertwined with other intentions, there can be confusion. David Geral sets out his concerns.
National Treasury’s Explanatory Memorandum on the Final Regulation 28 mentions that the aim of the regulation is to ensure that retirement savings are invested in a “prudent manner that not only protects the retirement fund member, but is channeled in ways that achieve economic development and growth”.
Reg 28 being the ultimate prudential investment regulatory instrument for SA pension funds, it is interesting that the word “prudent” is endowed with a meaning beyond its expected meanings like “safe”, “wise” or, at a push, “advisable”. Instead, National Treasury has sought to fold gently into the concept of prudence such additional meanings as “useful”, “convenient” or, alas, “expedient”.
I do not have concerns with governmental policy that seeks to leverage, for the good of the country, available capital to achieve economic development and growth. Neither do I have concern in principle with pension-fund assets playing an appropriate role in a national strategy to that effect.
My concern is the light-touch manner in which this significant policy position has been dealt with in the regulation and the Explanatory Memorandum. It does not do justice to the complex and material considerations of law, governance and fiduciary responsibility that are brought into play by the suggestion that prudential investment on the one hand, and targeted application of pension-fund assets on the other hand, necessarily co-exist comfortably.
This does not seem entirely appropriate since the regulation, while it is of interest and relevance to experts, is ultimately directed to pension-fund trustees. They display, according to government itself (and I don’t dispute this) “a general lack of investment expertise”.
The Explanatory Memorandum points out that “an important consideration is the level of expertise on boards of trustees and their ability not only to make investment decisions, but also to delegate certain tasks (but never their ultimate responsibility) to advisors like assets managers, asset consultants and risk consultants. Accordingly, the regulation must give stronger directions to rules rather than guiding principles”.
Geral . . . clarity gaps
The problem is that the predominantly rules–based regulation presents rules in relation to the easy stuff and presents principles, usually not that well enunciated, in respect of the difficult stuff. For example, in the preamble to the regulation it is correctly stated that a fund has a fiduciary duty to act in the best interests of its members. This entails the adoption of a responsible-investment approach suitable to the fund’s specific member profile, liquidity needs and liabilities.
Continuing its theme, the preamble states that “prudent investing should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of the fund’s assets, including factors of an environmental, social and governance (ESG) character”.
This statement does not give much guidance to trustees. It simply creates an expectation, or passively-stated obligation, on them.
Preambles usually do not contain much specific content. But in the present case the remainder of the regulation gives no more specific guidance than is given in the preamble. This is likely only to cause trustees who lack general expertise in relevant matters to rely more heavily on service providers (not always lawyers) to steer them along the tricky road of ESG investment now that the light has officially gone green.
Interesting about the nuance in the Explanatory Memorandum is that it echoes statements in National Treasury’s policy document, A Safer Financial Sector to Serve South Africa Better. Here the foreword by the Minister of Finance mentions that the “financial sector needs to do more to support the real economy and ongoing transformation of our society”.
That document hints clearly at possible regulatory intervention in public-sector retirement funds, not on the basis of their essential performance but also on their ability to satisfy the authorities that there is a justifiable basis for their “exemption” from the “private sector regulatory framework”.
The connection between this line of thinking and the statement in the first paragraph of the Explanatory Memorandum -- that “regulation 28 currently applies to all private retirement fund assets worth R1,1 trillion, and may be extended to the Government Employees Pension Fund (capturing an addition [sic] R1 trillion in assets)” is unavoidable.
Reg 28 also makes it an obligation of a fund and its board to consider the need to promote broad-based black economic empowerment of those providing services to the fund. The sentiment is not surprising or offensive. And it is not prescriptive.
But it does hint that a fund can expect oversight by the regulator in relation to its procurement practices. A fund whose performance in that regard is not impressive but whose operations, funding, general governance and the like are in good order, will hopefully be able to adopt an “avoid and explain” approach to questions from the regulator. It needs to be seen what steps, if any, are proposed in this regard.
Another slightly unexpected step, from a prudential perspective, is the fact that “Regional investment is further supported through the higher limits placed on unlisted debt and (directly held) unlisted equity…as this is where securities listed on foreign exchanges that are not WFE (World Federation of Exchanges) members are accommodated”. This is understood to be a mechanism to assist SA funds to access such unlisted investments on the African continent.
Together, those exposures can constitute up to 25% of a fund’s investments. Given government’s own assessment of a generally low level of expertise among fund board members; given that lack of capacity is cited as the primary reason for adopting a more rules-based approach, and given that the regulation is at pains to point out that the fund retains the responsibility for compliance with the regulation, it seems a bit inconsistent to adopt an approach to unlisted African equity and debt which could fairly be described as rather laissez-faire.
The regulation obliges a fund and its board to promote board education, which is undeniably important. However, in light of the regulation putting definite albeit subtle pressure on pension-fund boards to venture into the rather murky waters of ESG and unlisted African investments, one would have expected a commensurate drive from the state in relation to coordinated, effective, accessible board education.
The regulation does not give any indication as to the nature or minimum extent of board training. It certainly makes no mention of minimum qualifications, but perhaps one should not expect a regulation of this nature to address such issues.
Boards, even those which lack expertise, are usually aware that they do not even have the expertise to assess their service providers’ services, advice or due diligence recommendations. All they know is that those services are expensive. They do not necessarily know how to benchmark the value of these expenses when there is no measurable return on investment
The Explanatory Memorandum indicates that Reg 28 is a short to medium-term measure and hints at progression towards a more principles-based regulation in the future, when the general level of expertise among board members justifies greater departure from a rules-based approach.
In effect, this suggests that until private-sector initiatives to upskill trustees reach a satisfactory level, the industry can expect a predominately rules-based approach to prudential-investment regulation. Perhaps this is the carrot which National Treasury is dangling before the investment management, asset management and general consulting industries.