In recent weeks the Institute for Race Relations (IRR) launched a campaign against the possibility of government regulating that pension funds must invest in “prescribed assets” as a way of directing much-needed funds to sectors determined by government. As a result, an article entitled Why the government is eyeing your savings has been doing the rounds. With faith and trust in government-run institutions at rock bottom, our financial advisors have been inundated with queries and concerns about the implications of such a move.
In particular, concerns have been voiced that an attempt by government to leverage off South Africa’s R4 trillion in private pension may be possible under the Expropriation Bill 2019, which is currently before Parliament. It has been claimed that this move would put personal pension funds and savings at risk.
While it is always vital to keep a close eye on political and legislative developments, particularly in light of the ongoing state capture revelations at the Zondo Commission of Inquiry, we believe the approach behind the IRR campaign errs on the negative. It is essential to offer an unbiased and clear view of the proposal, the potential impact thereof, the likelihood of this being regulated and then to share with you how we are dealing with these developments.
LET’S CONSIDER REGULATION 28
South Africa’s framework for investment regulation is well established, and the most important piece of regulation that specifically addresses maximums and minimums of investments is contained in what is known as “Regulation 28”.
According to Citadel’s Chief Investment Officer, George Herman: “Regulation 28 is a commonly used term in the financial markets and should government decide to channel investment to specific causes, the channel through which they would do it is through an adjustment to Regulation 28. But Regulation 28 is only applicable to retirement funds – so an immediate distinction must be made in this debate between discretionary investments and retirement funds.”
A change to Regulation 28 would not give government the ability to touch discretionary assets – investments that are managed by an authorised broker or wealth management firm capable of buying and selling on behalf of a client based on a specified mandate.
“Doing so would require a major stretch of the current debate around expropriation of assets without compensation, and I don’t think we are close to that at all,” says Herman. “That expropriation debate is based mainly around land. The problem is that much of the language around expropriation talks about property and, at a stretch, property could be seen as assets. We do not believe government is aiming at property, they are focused on land. Therefore, any change to Regulation 28 would only affect pension products.”
HOW WOULD PRESCRIBED ASSETS WORK?
“The history of prescribed assets, something the South African market has experienced in the past when the National Party government legislated for prescribed assets in pension funds in the 1970s, doesn’t make it right or good, in fact everything that regime did around those issues were seen as negative”, says Herman. “So there is no way we can use the fact that we had asset prescription in the past as validation of having them now.”
“Ultimately, the use of prescribed assets is a direct interference by government in the free choice of investment trustees to direct the investment activities of pension funds”, says Herman. “It has political influences and it distorts the optimal portfolio construction of those underlying portfolios. So it will be viewed as a very negative event if prescribed assets are brought into Regulation 28.”
WHAT WOULD THIS MEAN IN REALITY?
In short, asset prescription regulation would likely force all pension funds to buy a minimum amount of government bonds. Currently all South African pension funds have some exposure to government bonds. So, it is not to say that if a minimum prescribed amount were set, that this would have a huge impact, since most pension funds would already own government bonds as part of their diversification strategies into a long-term investment product.
However, if government looks to institute a substantial percentage then this would become a problem. In 1977, the stipulation was as high as 77%. Something of this nature would be cataclysmic and lead to an enormous outflow of money as foreign investors become fearful, despite not being affected. What this approach fails to take into account is that foreign investors would see the changing tide and be concerned that government would next target discretionary investments and foreign money. Foreign investors would certainly run in advance of that.
Citadel is of the view that there is indeed a possibility of asset prescription regulation being enacted, due to the exceptionally negative sentiment in the markets around Eskom and the slippery slope the parastatal finds itself in: Effectively shut out of the financial markets and unable to raise tariffs due to the National Energy Regulator’s intervention.
Again, given this sentiment, the level at which government chooses to pitch prescribed assets becomes all important. We don’t believe government would be aggressive in this regard. Therefore, the impact would be minimal.
Further to this, in an environment where discretionary money is nervous and careful about investing in government bonds, the liquidity will decrease and yields will probably end up rising. So although pension funds might be forced to invest in them, they will actually be investing in higher yields, which would soften the blow and make the move less drastic.
This is, as opposed to the IRR campaign, a more pragmatic view on the situation, which is divorced from the fearmongering out there at the moment. Unfortunately, the degree of trust in South Africa’s state-run institutions is currently at record lows and the financial bottomless pit into which pensions would be forced to invest in is creating uncertainty in the market.
WHAT ARE WE DOING?
Right now, Citadel is actively participating in industry negotiations with National Treasury around prescribed assets. A subcommittee at the Association for Savings and Investment South Africa (ASISA) is working on this issue and we are giving input as part of this process.
Citadel is bound to operate in accordance with Regulation 28 and cannot flout its stipulations. Since it is clear that this proposal would only affect your pension assets, we can step in and prepare for this eventuality through smart planning around your pension and discretionary assets. Whenever there are amounts inside your pensionable assets that can be withdrawn and made discretionary, that should be done.
“We will continue to highlight the possible risks that could emanate from prescribed assets, as well as any discretionary investment and foreign investment opportunities that would mitigate those risks, in line with each client’s specific risk profile,” says Herman.
What is important to note is that this process, should it unfold, will take time. It would be a long process and would involve a significant lead-up time.
Finally, Herman adds that once a solution is found to the problems at Eskom, then a move towards prescribed assets may not even be necessary. “ASISA is also working on a solution to show government that the private sector could come up with solutions for Eskom,” he says. “So I believe there is a bigger probability that the private sector will assist in finding a credible solution to Eskom’s funding problems than there is for prescribes being installed.”
While there is a notable amount of uncertainty in the market around the issue of prescribed assets, and we suggest our clients to speak to their financial advisors around these concerns, rest assured that Citadel remains part of this delicate process and, as always, it is your best interests which inform our actions. We will continue to communicate on this issue as it unfolds.