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Can Regulation 28 Revive Economic Growth?

May, 2020 - Human beings are remarkably resilient, adaptable, and even in the most trying times, optimistic. But as the health, social, and economic impacts of the Covid-19 pandemic steamroll through our neighbourhoods, we find ourselves reaching compulsively for our little bottles of hand sanitiser. “The whole world seems upside-down,” was a sentiment recorded by an American letter writer living through the global Spanish flu epidemic of 1918. That sentiment is not so distant from how we feel now. The difference for South Africa is the epidemic arrived on the back of an economic downturn characterised by an era of corporate corruption. How we emerge from this crisis is extremely important. However, there is room for optimism if we can realise investment opportunities within South Africa’s real economy.

There has recently been much discussion around Regulation 28 which controls the allocation of pension fund assets. Many, including SAVCA, have expressed the value of using Regulation 28 to drive the type of investments that revive economic growth. We have a real opportunity to respond to our local economic circumstances. Discussions around the “why” and “how” of Regulation 28 reflect this. However, let’s take a step back and give some context to the value of this policy and what it can do for our economy.

Regulation 28 was instituted by the National Treasury in 2011 and is enforced by the Financial Services Conduct Authority (FSCA). It gives guidance on the limits of investment that a pension fund can make into a particular class of product. The premise was that there needed to be a guideline that encouraged both investment diversification and managed risk by limiting how much exposure an investment could have to an alternative asset class which was deemed riskier at the time.

The preamble highlights the fiduciary duty of pension and provident fund boards to invest members’ deferred wages in a manner that shows that they have considered the long-term value growth of the assets of their members while applying consideration of ESG factors. Fund custodians (the trustees) are required to formulate their investment strategy on the foundation of their understanding of Regulation 28. It is clear from the preamble that an overly conservative investment strategy dominated by factors like cash and non-inflation-linked bonds can be as damaging to long-term savings as one that is too exposed to what many would class as riskier assets. Regulation 28 rules are designed to ensure the right mix of low-risk-return “safe” assets with higher-risk-return innovative products.

Regulation 28 later expanded to include principles aimed at strengthening the investment decision-making process and allowing for checks and balances in the retirement fund process. The type of assets a fund can invest in is limited to those specified in the regulation and within the regulation’s defined issuer and aggregate limits. However, the regulation also makes room for involuntary breaches the board cannot control, for example, changes in position as a result of the immense market movements linked to Covid-19 in 2020. The limits are not meant to restrict the funds’ performance. Where funds reach their limits but think it is in the members' best interest to exceed them, the board can engage the Registrar and request an exemption. Retirement products must be compliant at both the fund level and member level to safeguard members and limit exposure to risky assets. Keep in mind that economic development is better supported when funds have greater flexibility to invest in private equity funds and public debt.

As we wait to hear about the reforms to Regulation 28, we hope that any changes will provide a greater chance of turning the current dire situation from impending calamity into a realised opportunity. We are optimistic that a new set of principles will be introduced to address the gaping socio-economic imbalance by directing investment into areas where it is needed most. Investment into goods and services in our second cities can boost the real economy, creating jobs, and reducing urban migration. Lastly, we hope the draft legislation will incentivise the development and use of local skills and reward companies which reflect the economically active population in their areas of investment.

Private Equity's Place in the Pension Fund Investment Universe: Driving South Africa's Economic Growth

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