IRF Trustee Workshops March & April 2012 Cape Town, Durban, Gauteng REGULATION 28 implementation Financial Services

1. IRF Trustee Workshops March & April 2012 Cape Town, Durban, Gauteng REGULATION 28 implementation Financial Services Board Ms Wilma Mokupo Head: Pensions (Prudential Supervision)

2. Regulation 28 revision process • First draft issued Feb 2010 • Second draft issued Dec 2010 • Gazetted into law Feb 2011 • Effective date Reg28 1 July 2011 • Grandfathering principle applies 1 April 2011 • Notices & audit report issued December 2011 • Notices issued March 2012

3. Regulation 28 revision process • Regulation 28 gazetted into law: • w.e.f 1 July 2011 • Gazette 34070 • Final regulation 28 with Explanatory Memo and matrix of comments: • Reg28 published in Gov Gazette, part 1 • Reg28 published in Gov Gazette, part 2 • Continuous compliance (fund + members) • Explanatory memorandum (EM) • Matrix of public comments

4. Reasons for revision Reg 28 • History: prescribed assets 53%, only rules-based then asset limits • Reference to old Acts fixed • Inconsistency RF, Insurance, other investment vehicles • Rules based approach vs appropriate investment strategy for your fund • To close loopholes • New investment channels not accommodated • Increased foreign exposure • Exclusion guaranteed policies with insurers exceeding Reg28 limit with minimal underwriting protection • Limits encouraged “herd mentality” amongst asset managers vs appropriate fund assets e.g. alternative investments & structured products • No member level protection vs fund compliance as a whole • Credit risk may be an issue – attract same limits irrespective credit profile • Accommodation of Islamic debt instruments

5. Regulation 28 combines rules & principles • Lessons from GFC still need rules • Principles: comply at all times & IPS • Further Board must - • Spirit of the regulation (EM) • Improve trustee education • Check compliance by advisors & service providers • In contracting consider B-BBEE • Assets appropriate for liabilities (ALM) • Understanding changing risk profile (risk analysis & foreign risk exposure) • Member level compliance & look through principle • Due diligence NB • Sustainable investing – ESG

6. Regulation 28 Notices • NT & FSB press releases (NT roadshows engagements past 2 yrs) • Transitional arrangements (Notice 1&2 of 2011) • Notice 1: Quarterly reporting (continuous compliance) • Notice 2: General conditional exemption under s36 till 31 December 2011 “funds not less compliant” • Notice 3: Prescribed format for reporting, Reg28 audit report • Notice 4: Public entities for purposes of par 2.1(d) • Notice 5: Conditions for securities lending transactions

7. Revised Regulation 28 • Exclusions: only 3 • Linked policies (Reg28 compliant cert) • Guaranteed policies (Reg 28 compliant cert) draft Directive 157.A.i (LT) • CIS (Reg28 compliant cert) • Scheme/ LT insurer issues cert of compliance with Reg 28 • At yr end of CIS or LT Insurer auditor of CIS/ LT insurer certifies that certificates issued throughout period complied with Reg28 • Auditor’s cert issued to fund on request • Islamic debt instruments are now specifically included & defined

8. Revised limits & sub-limits

9. What trustees need to ask each other? • Do we understand our roles & responsibilities of trustees, administrators, agents mandates, etc & oversight in the light of the revised Reg28? • How does it affect the Fund’s decisions going forward & what do we need to revise/ change in the light of the new requirements? • Do we need to align our existing IPS (investment policy statement) to address the issues of alternative investments, scrip lending, foreign exposure, B-BBEEE, ESG etc? • What is a sensible governance model to execute the Fund’s investment strategy or how to align the existing structures? • What is in the best interest of all members in ensuring member-level compliance? • What is likely to help members reach their retirement goals? • Does the board as a collective have the sufficient knowledge to conduct a reasonable due diligence? • If we delegate our functions how to we stay in control and ensure effective oversight at all times, as responsibility cannot be delegated?

10. What trustees need to ask each other? • How are we going to assess the appropriateness of assets & liabilities for our unique member profile? • How are we going to perform appropriate due diligence of our asset managers (including offshore ones) • How are we going to assess our investment strategies & conduct risk assessments? • Are we/ Do we want to invest in Africa, hedge funds, private equity or ETFs and what are the risks regarding alternative investments structures? Do we understand these risks? e.g. can we can loose up to 25% for counterparty defaults? What is quality collateral? etc • Do we understand the benefits of taking environmental social and governance (ESG) factors into account when making investment decisions? What are the risks associated with these? Are these any different? What questions do we ask to assess the appropriateness & benefits for our fund? see CRISA code • see Circular PF130 and Annexure B for details

11. What trustees need to consider in IPS? • Have you considered following when developing IPS: • Current investments • Degree of risk tolerance • Volatility of contributions • Current & future liabilities • Structure of your fund DB or DC or hybrid • Liquidity & cash flow requirements • Maturity of your fund • Profile of your members & beneficiaries • Essential elements of an IPS: • Asset mix & expected rate of return • Categories of investments e.g. list of acceptable derivative instruments to be used by the fund, if any) (see Notice conditions for the use of derivatives by retirement funds) • Diversification • Liquidity requirements • Pledging & borrowing of fund assets (exercise extreme care) • Securities lending (see Notice containing conditions) • Management fees & compensation • SRI • Voting rights • Valuation procedures • Related party transactions • See Annexure B to Circular Pf 130 for further details

12. What trustees need to ask of investment managers: • What processes & procedures are we going to insist on to arrive at a justifiable decision? • Do we take a more active interest in proxy voting ( e.g. via securities lending)? How has our asset manager(s) been voting on our fund’s behalf, if at all? • Do we rewrite our management agreements & mandates with our asset managers? • Do we ask for more regular feedback from asset managers? • How & when should breaches be reported & corrective action taken? What is the cause of the breaches? e.g. do we have any out of mandate trades/ member switches/ market movements that caused non compliance? • Do we ask for more meaningful reporting from all service providers so as to better monitor & measure their performance or lack thereof & report breaches to Registrar within the required timeframes (quarterly, annually)? • Note: even if the board of trustees outsource these functions they will still be held jointly and severally liable as the fiduciaries/ decision-makers of the fund

13. What trustees need to ask of the benefit administrator: • What systems changes have been implemented since the publication of the revisions to Reg 28? • What types of breach reports can be provided to the fund and how often? By whom, when & how? i.e. level, frequency, responsible person, etc • How many member portfolios/ offerings are non compliant with Reg28? • What does the benefit administrator’s implementation plan look like? e.g. capacity, resources, restrictions (if any)? • What changes has been made to the systems (if any) to ensure on-going compliance monitoring? e.g. compliance monitoring at fund level, member level, sub limit levels, asset classes? • What is the extent of the administrator’s legal liability? e.g. wrong switches? Does the admin agreement sufficiently cover these issues? • What is the level of adherence to the fund rules, mandates, admin agreement, service level agreement? etc • see Circular PF130 for details

14. Notice 4 on Public Entities (issued) • Entities as prescribed for purposes of paragraph 2.1(d) of the Table to Regulation 28: Approved Public Entities – • 1. Airports Company of South Africa Limited (ACSA) • 2. Development Bank of Southern Africa (DBSA) • 3. ESKOM • 4. Industrial Development Corporation of South Africa (IDC) • 5. Land and Agricultural Development Bank of South Africa • 6. Trans-Caledon Tunnel Authority • 7. Transnet Limited • 8. The South African National Roads Agency Limited (SANRAL) • 9. Rand Water • 10. Umgeni Water

15. Notice 5 Securities lending (issued) • Conditions for securities lending transactions: • Safe & prudent manner itosecurities lending policy of fund • Fees & income to the benefit of the fund • Fund must ensure controls, procedures are sound • Where admin of securities lending is outsourced check: • Institution has necessary competence, experience & expertise to perform duties • Administrative & reporting arrangements clearly set out & agreed in writing • Perform a due diligence on the counterparty & institutions to whom the administration is outsourced & consider credit risk, credit rating, liquidity & volatility of the counterparty prior to transacting • Listed counterparties for securities lending: • South African & foreign banks, CIS, LT insurers • Authorised users of an exchange as defined in the SSA • NT, SARB, JSE Ltd • Adequate Collateral security (cash 105% debt 110% equities 115%) • Contractual arrangements (minimum requirements) • Advisable transactions may not exceed 12 months • Disclosure of securities lending transactions

16. Notice 5 Securities lending (issued) • Can only engage in securities lending consisting of: • listed equity • listed debt instruments • money mkt instruments issued by a bank • listed assets which reference a listed underlying asset(s) • Securities lending transaction limits • The aggregate value of all equity, money market and debt instruments that are the subject of securities lending transactions may not at any time exceed:- • Equities – Top 100 of companies (by market cap) listed on an exchange 75% • Other listed equities 50% • Debt – Government bonds 75% • Other listed debt instruments 50% • Money Market Instruments issued by a South African bank, including an Islamic liquidity management financial instrument 75% • Note: Where the fund has entered into a securities lending transaction and the listed equity delists during the reporting period, the fund must apply to the Registrar for exemption in respect of the relevant transaction. • see Notice 5 for further details

17. DraftNotice on Guaranteed Insurance Policies: certificate to be issued by statutory actuary ito Reg28(8)(b)(iii) • Definitions Reg28 vs definitions Part 5 of Insurance Regulations (LTIA prevails where there is a conflict) • Reg28(8)(b)(iii) allows exclusion of guaranteed policies that meet criteria of Registrar of Insurance: • The policy benefit must be ascertainable; • A policy guarantees policy benefits if the statutory actuary provides the confirmation on retirement of a fund member in the case of: • A fund member policy • A fund policy • In respect of each annuity installment for the lifetime of the annuitant in the case of an annuity

18. DraftNotice on Private Equity • In terms of Section 5(2) of the PFA: fund beneficial owner of all its assets, therefore: • Structures approved by Registrar ito section 5(2)(e ) as follows: • En commandite partnerships s.t. conditions • Bewind trusts s.t. conditions • Company structure s.t. conditions • PE fund member recognised industry body by Registrar • Foreign PE fund s.t • Limited partnership • OEIC • Company if assets & liabilities are limited to assets & liab investments made by PE fund itself • Financial Services • Any person rendering services to PE fund (local/ foreign) must be a discretionary FSP or representative of a discretionary FSP • Conflict of interest • Disclosure by responsible person, manager, administrator, or advisor of PE Fund both direct & indirect benefits arising from any transaction(s) including disposal or acquisition of assets • Investment reports • Quarterly reporting on performance, activities & values & reporting info to trustees • Confirmation of assets • Verification of assets by auditors of PE fund through scrip count

19. DraftNotice on Private Equity • Suitability of investment before investing trustees must consider: • PE fund’s investment strategy objectives, borrowing powers, restrictions & associated (types & sources of leverage) • Procedures followed by PE fund to change its investment strategy & policy • Details of valuator, auditor, administrator & any service provider of PE fund & description of duties • Details fund’s rights i.t.o contractual breach by PE fund and its service providers • Safeguarding of PE fund’s assets • Liquidity risk management (liquidity requirements, liability profile & fair treatment across investors) • Management fees, performance fees, initial charges or early redemption fees etc charged by PE fund • Responsible person’s risk & compliance management policies & procedures to ensure compliance with its policies etc and does person demonstrate sufficient independence from those managing the assets of the PE fund • Portfolio valuation • Fund can only invest in PE fund that has clear policies & procedures to determine the fair value of the assets of the PE fund i.t.o. International Private Equity Valuation Guidelines • Valuation of assets must be independently verified at least annually by third party • Auditing requirements • Financial statements of a PE fund s.t. annual audit by an auditor ito International Standards on Auditing (IAS) and prepared in accordance with IRFS to fairly present its financial position & made available within 120 days after PE fund’s year end • Transition period: comply by no later than 30 Sept 2012 • Funds to seek professional advice when investing in complex structures and fully understand risks & protect fund assets

20. DraftNotice on Hedge funds • FAIS Act set minimum requirements for asset managers/ Category IIA FAIS license • Regulatory concerns around Hedge Funds & FOHF: • Leverage • Significant performance fees • Investors permitted to redeem their interest only periodically • Often own funds invested by the manager “skin in the game” • Derivatives are used for speculative purposes • Short selling • Diverse risks & complex underlying products involved • Details to be finalised with CIS, Insurance, FAIS dept & Pensions dept of FSB

21. DraftNotice on Derivatives • Principles for use of derivatives same Reg28 principles: • Derivatives may not be used to circumvent Reg28 • Look-through principle applies hence classified according to the underlying asset (matching) • May be used solely to reduce / hedge investment risk or liability risk & for efficient portfolio mnt (EPM) • No gearing/ leveraging may be used • Covered positions at all times • Residual risk/ exposure must be disclosed after netting off must be similar when netting off (highly correlated) • Collateralisation • Agreements ISDA compliant • Disclosure & Reporting (revised Schedule IA, IB in financials with revised audit reports to be issued soon consultation with industry, SAICA & IRBA being finalised)

22. DraftNotice on Derivatives • Trustees responsibilities i.r.o use of derivative instruments: • Assess current use of alternative assets (who, to what extent, costs etc) • Assess process & timeframes for reporting of breaches & implementation of corrective action e.g. out-of-mandate-trades • Reporting by asset managers done in a manner that allows benefit administrator & Board to effectively manage & monitor & take corrective action in good time • Revise mandates and align with fund’s revised Investment Policy Statement • Set down properly authorised & signed mandates ensuring service providers clearly understand Board will not tolerate non compliance (incl. redress, exit clause, stop loss, etc) • Trustee training & up skilling to understand unique risks of derivatives & alternative investments • Monitor the actual investments not just adherence to policy • Assess risks including counterparty risk that it is well understood & managed adequately • Assess quality of collateral provided (ratings can assist but not sole criteria) • Valuations & valuation methodology used

23. Future Regulatory Landscape RSA • Some responses to global financial crisis GFC: • Proposed regulation of OTC mkts ? • Proposed regulation of Credit rating agencies “Credit Rating Services Bill, 2011” • Revision of SSA - “Financial Markets Bill, 2011” • Regulation of Hedge fund managers & FoHFs • SAM (Solvency Assessment & Management) for Insurers • Red Book on Twin Peak Model • “A safer financial sector to serve South Africa better”

24. Red Book on Twin Peak Model • 7 Chapters Feb 2011 • Chapter 1: Overview • Policy priority 1: Financial stability • Chapter 2: Lessons from GFC • Chapter 3: Strengthening the regulatory framework • Policy priority 2: Consumer protection & market conduct • Chapter 4: Protecting consumers of financial services • Chapter 5: Safeguarding pensioners • Policy priority 3: Expanding access through financial inclusion • Chapter 6: Access to financial services • Policy priority 4: Combating financial crime • Chapter 7: Combating financial crime

25. King III states • Retirement fund “boards… must act for the ultimate beneficiaries, who are individuals. The ultimate beneficiaries of retirement funds, which are currently among the largest holders of equities in South Africa, are individuals who have become the new owners of capital.” • Members of retirement funds are financial decision makers and so are their boards who invest on their behalf over R2.3 trillion assets today! • It is therefore critical that boards take account of the principle of “shareholder activism” and must therefore ensure that the fund itself, or - where an investment manager will be exercising the voting on behalf of the fund, that voting occurs in accordance with the instruction of the boards.

26. Due diligence… • Trustees are the DECISION MAKERS • Act in the best interest of all members at all times • ACT NOW – it is never too late!!! • If you Don’t Act …. there will be consequences for your failure

27. Is your fund fully compliant with Regulation 28?YES 100% compliance at member levelOur Fund offers only compliant CIS, Policies & Trustee default portfolio fully Reg28 compliant

28. Almost there…Our Fund is 95% compliant at member levelLess than 5% of our portfolios/ member offerings are non compliantThis is mainly in the RA & preservation fund spaceWill be fully compliant by end Quarter 2 of 2012

29. Not yet Reg 28 compliantOur Fund operates mainly in the segregated or specialist mandates spaceOur administrators are reviewing their business models, systems, etcWe require 3 to 6 months extension/ exemption?

30. To grant or not to grant exemptions or extensions for implementation to Reg 28: • Transition period 1 July to 31 December 2011 published March 2011 already • Registrar extremely concerned about “wait & see approach of industry” • Progress since July 2011 “snapshot to be given by auditors funds not less compliant with revised Reg28” • Regulatory action may include but not limited to: • Administrative penalty; and- or • On-site investigations; and - or • Referral to Enforcement Committee of FSB; and-or • Issuing of Directive 33A, etc • Serious concerns around regulatory arbitrage (needs further engagement with ASISA, IRF, POA etc to find factual basis, where practically impedes after Q1 Q2 submissions)

31. Themes discussed with auditing profession (SAICA & IRBA) • Similar approach when audit exemption was withdrawn for first time for all underwritten funds in 2006 (agreed on themes/ wording for qualification on opening balances) • Revised audit report issued December 2011 • Revised Schedule IA, Schedule IB and quarterly report to be issued March 2012 • Possible audit qualifications: • Non compliance at member level; • Non compliance due to market fluctuations (12 months to rectify); • Non compliance at sub- limit levels e.g. immov prop • Challenges: • Transition period needed for implementation of new Notices on securities lending, derivatives, hedge funds, private equity etc. • Exclusions not yet finalised for “guaranteed” policies LTIA • Due dates for quarterly reports

32. Financial statements as a governance tool ! It has everything you need on financial activities of your fund Use your financial statements & other financial info as a Governance Tool Have direct access to your auditor with regards to fund financials, when necessary Engage auditor & ask for assistance with interpretation issues around Regulation 28 Seek independent legal advice if the costs justify it (cost v benefit)

34. Useful links • www.treasury.gov.za • www.fsb.co.za • www.trusteetoolkit.co.za • Wilma.Mokupo@FSB.co.za