Edition: August/October 2018
Governance up for debate
FSCA draft notice sets cat amongst pigeons on role of sponsors and ‘independent’ trustees. Participating employers and fund members had better pay close attention.
Having come prepared for a pleasant breakfast with members of the Pension Lawyers Association, the atmosphere was cordial enough. But the amiability disguised the sharpness of dispute between Rosemary Hunter, the former regulator now at law firm Fasken, and Kobus Hanekom, principal officer of the Sanlam Umbrella Fund.
They were at daggers drawn on fundamental aspects of the draft guidance notice, issued by the Financial Sector Conduct Authority, to allow a general exemption from the requirement that members of a retirement fund have the right to elect members of funds’ boards. Particularly concerned with commercial umbrella funds, Hunter cautioned on the legalities and Hanekom focused on the practicalities; both within the context of fund members’ best value for money.
Olano Makhubela, who issued the FSCA notice, must have had little idea of what he’d unleashed. The comments he’d invited he certainly got. Wish him well in deciding what to do with them. The more that standalone funds are collapsed into umbrellas – Makhublela envisages that ultimately there will be only 200 funds, all mega-umbrellas – the more pressing that the points of departure are resolved.
In the 1990s, trade unions fought hard for the right of members to elect up to 50% of trustees. Then followed the advent of commercial umbrellas and, with it, an exemption from this requirement. Now comes the notice that seeks to “clarify and reflect” the FSCA’s position in granting exemptions.
Mostly, it was agreed by Hunter and Hanekom, the proposed amendment to s7B of the Pension Funds Act represented “good progress”. But that’s about where agreement ended and contention began. It essentially revolved around the role of pension funds, whether conventionally as not-for-profit vehicles whose boards acted in the best interests of the fund or as umbrellas whose boards could be swayed by the for-profit interests of their sponsors.
Hunter stressed that any power of exemption had to be exercised sparingly, not generally, or the rule of law and value of accountability would be undermined. Funds’ sponsors could not be regarded as ‘material stakeholders’, which the notice contemplates, and should not be allowed to appoint board members.
In a nutshell, for the sponsor to appoint trustees invited unavoidable interest conflicts by compromising the ‘independent discretion’ they were obliged to exercise; for instance, on the selection of services providers. Where the sponsor is a life office, also owning an asset manager and a consultancy amongst other services, the sponsor-nominated trustees should not be conflicted between the best interests of the fund and the profit interests of the sponsor.
The way to avoid such conflicts would be for all trustees to be independent of the sponsor, she urged. The board of trustees may not treat the fund as a ‘product’ or a vehicle for delivery of ‘products’ to fund members.
Hanekom doesn’t see it that way. The mega-fund environment represented a “paradigm shift” from the traditional standalone corporate fund where 50/50 employer/member representation prevailed at board level. In this new environment, the umbrella fund must have a sponsor which has to be a large institution that the membership trusts and which has the discipline as well as the muscle to weather financial storms.
One might have thought that the notice offered an accommodation of both arguments. But apparently it doesn’t.
It proposes that the FSCA will grant exemptions to commercial umbrellas provided that at least 50% of the board members, who must have “relevant experience or expertise”, are independent i.e. “free from any relationships that could . . . be considered as something that would affect their objectivity”. Moreover, board decisions will only be binding if they are supported by at least 70% of the independents.
This is described by Hanekom as highly problematic. It effectively gives the independents a veto right, concentrating in them “an extraordinary amount of power”, enabling them even to put into place a competitor’s default investment portfolio without any support or despite protestations from the sponsor-nominated trustees.
The relationship between the sponsor and the fund is primarily contractual. Thus, he suggested to Hunter’s chagrin, the consequence is “akin to a product designed and supported by the sponsor”. In terms of this approach, the sponsor takes responsibility for the research, development and design of the “packaged retirement-fund solution”. Once considered and approved by the board, this solution is then directed, controlled and overseen by the umbrella’s board in compliance with the Act.
Then take some specific proposals.
Hanekom: I fully support this measure.
Hunter: I do not. The principal officers of exempted funds merely need to set up a reminder on their computers to apply for a fresh exemption before the existing one expires. Regular reconsideration by the regulator is important.
Hanekom: No election is required. The fund appears free to find a way in which to appoint independent trustees. Also, the unequal treatment of commercial versus non-commercial umbrella funds is unjustified.
Hunter: This is inconsistent with the object of the Act at s7A. Also, it’s insufficient for compliance with the law or to ensure that the board does not use its powers principally for the benefit of the fund’s sponsor. Some funds with 50% independents still seem ‘captured’.
Hanekom: Not practical. Ignores the facts that some sub-committees operate within narrow mandates given to them by main boards, and that some include external experts for good reason.
Hunter: Agreed. Further, any member of a subcommittee who seems unable to exercise an independent discretion should be expelled from it.
Hanekom: Already provided for in relation to all board members.
Hunter: Agreed. Superfluous.
Hanekom: This would give the independents effective veto rights and allow them to choose investment portfolios provided by sponsors’ competitors. The independents could ‘capture’ the funds.
Hunter: If they had good reason for thinking the competitors’ portfolios were best of breed, this would be a good result. Commercial umbrella funds can be captured by their sponsors even if 50% of their trustees are ‘independent’ or ‘member-elected’. Better if all were independent.
Hanekom: Unsure what this means. Will joint forums or local boards, at the level of each participating employer, become compulsory for each employer? How can the size of the umbrella fund – or is it the size of the employer – determine the need for a manco?
Hunter: A subordinate governance structure does not have to be employer-based. It could be determined by reference to region, occupation, industry or some other basis for community of interest. Mancos can be committees of the umbrella fund, to assist the board better to liaise with members and employers. In this way they’d ensure adequate and timeous communication, interaction and understanding of matters which impact these stakeholders.
Okay, Olano, over to you. But even more than the regulator and the sponsors, employers and fund members had better pay close attention too. It’s primarily their interests at stake.